&EPA
United States
Environmental Protection
Agency	
Pollution Prevention
and Toxics
(7406)	
EPA 744-B-96-001
September 1995
Environmental Cost Accounting
       and Capital Budgeting

  Handouts to Accompany Videotape Seminar
    Sponsored by the U.S. Environmental Protection Agency's
          Design for the Environment Program and
      the National Institute of Standards and Technology's
           Manufacturing Extension Partnership

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     NIU
Professional Development
Videoconf erence for Technical
Assistance Providers

Environmental  Cost

Accounting and Capital

Budgeting _ _

Wednesday, July 1 2, 1 995
8am-2pm Pacific • 9am-3pm Mtn • 10am-4pm Central • 11am-5pm ET
Live, Interactive Satellite Broadcast for Technical Assistance Providers

Seminar Description
 Many firms are not aware of the full range of environmental costs
(or savings) associated with their manufacturing operations. Such
costs result from product design decisions/ choice of process technol-
ogy, and waste management practices. In today's rapidly changing
regulatory environment and increasingly competitive marketplace,
environmental costs can make the difference between profitable and
unprofitable product lines and capital investments.
  Identifying, tracking, reporting and using environmental cost
information to support internal management decision-making is
integral to remaining ahead of environmental regulations and ensur-
ing long-term business competitiveness both in the U.S. and abroad.
Benefits
This seminar will:
• introduce the elements of environmental accounting, with a special
  focus on the financial analysis of pollution prevention and other
  environmental capital projects
• review the basic mechanisms of conventional project profitability
  analysis, as well as the elements of Total Cost Assessment (TCA), a
  methodology for the comprehensive financial assessment of envi-
  ronmental projects, and
•  provide actual applications of TCA to illustrate the value of adopt-
  ing a TCA approach to ensure that prevention-oriented projects are
  given a "level playing field" when firms consider how best to
  allocate their capital resources across market expansion, cost-
  reduction, and compliance" investments.
 Sponsored by: The U.S. Environmental Protection Agency
     (EPA), and the National Institute of Standards &
    Technology (NIST), U.S. Department of Commerce

                 United States Department of Commerce
                 National Institute of Standards and Technology
Speakers
This live, interactive seminar will
feature presentations by Allen
White, Ph.D., and Deborah
Savage, Ph.D., experts in
financial analysis of pollution
prevention projects. Bill
Schwalm, manager of
Environmental Programs
Manufacturing for Polaroid
Corporation, Waltham,
Massachusetts, will discuss the
corporation's environmental

cost accounting system.


Moderator

Mike Jackson
who serves as moderator for
the Modem Manufacturing
Videoconference Series, is
owner of a Chicago-based
corporate communications
consulting firm, Jackson
Communications Management,
Inc. A former Chicago
television news anchor and
reporter, Jackson holds an M.S.
degree from Northwestern
University. His firm provides
internal and external corporate
communications services, video
production and presentation
training.
  To register, contact the Manufacturing Extension office in your area,
                                                                      Continuing
                                                                      Education
                                                                      Units: .5
                 or call NTU at (970) 495-6424
                                                            Course Code: MC95071201

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                                        Page 2	_____^__
                                      Modem Manufacturing Series
                                                                         July 12,1995
Intended Audience
The seminar is designed for trainers and technical assistance providers in the areas of industrial
environmental management and project profitability analysis, especially those whose work is oriented
to pollution prevention and waste minimization in manufacturing firms. The information and ex-
amples presented will be accessible both to viewers with little previous exposure to financial analysis
methods and to those with some experience in this area. Viewers with a formal background in indus-
trial, materials, product and environmental engineering, accounting, and general business management
will benefit.
Company Case Study
Bill Schwalm, Environmental Programs Manufacturing, Polaroid Corporation, Waltham, Massachu-
setts, will discuss Polaroid's Environmental Accounting and Reporting System (EARS) and also
Polaroid's Total Quality Ownership (TQO) initiative, the goals of which are to build environmental
goals into business systems and improve both simultaneously.  With respect to the implementation of
Total Cost Assessment (TCA) of pollution projects, Bill Schwalm and colleagues will discuss a recent
capital project involving the installation of a closed-loop, multi-purpose solvent recovery still at a
Polaroid facility.
Presenters
                           Allen L. White
                           is Vice President
                           and Director of
                           the Risk Analysis
                           Group at Tellus
                           Institute in
                           Boston.  Dr.
                           White's work
                           focuses in four
                           areas: environ-
                           mental account-
                           ing, pollution
                           prevention
                           economics,
                           corporate envi-
ronmental performance indicators, and life cycle
analysis. He has managed projects for the U.S.
EPA, state governments, and. numerous corpora-
tions on Total Cost Assessment (TCA), an alter-
native approach to evaluating the profitability of
corporate pollution prevention investments. In
work with the private sector, projects have
included assessment of the managerial account-
ing practices and the financial analyses of spe-
cific projects in the chemical, pulp and paper,
automotive, pharmaceutical, metal fabrication,
and other sectors. Most recently, he initiated
projects for U.S. EPA on the economics of cleaner
technologies in the dry cleaning and printing
industries.
                          Deborah E.
                          Savage,
                          a Ph.D. chemical,
                          engineer, is a
                          research associ-
                          ate in the Risk
                          Analysis Group
                          at Tellus Insti-
                          tute. Her aca-
                          demic back-
                          ground includes
                          teaching experi-
                          ence at both the
                          undergraduate
                          and graduate
levels. At Tellus, Dr. Savage focuses on pollu-
tion prevention and cost accounting. She has
assisted a number of industrial firms in the
financial analysis of pollution prevention
projects, including those in the automotive,
printing, and chemicals sectors.  In addition, she
has collaborated on TCA projects with the states
of New Jersey and Illinois. Dr. Savage is a
Visiting Lecturer in the Chemical
Engineering Department at MIT.

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 Revised Broadcast Schedule
 (All times listed are Eastern Time)
 11:15-11:45
 Environmental Cost Accounting and Capital Budgeting
 Allen L. White, Ph.D.
 Tellus Institute, Boston, MA
         What is environmental accounting?
         How can environmental  accounting benefit business operations?
         Comments from an industry supporter of environmental  accounting
         U.S. EPA's Design for the Environment (DfE) Program
         What is the connection between capital budgeting and environmental accounting?
         Project feasibility  analysis
11:45-11:55
Question-and-Answer Session
Mike Jackson, Moderator
11:55-12:30
Lunch Break
12:30-1:20
Basic Concepts of Project Financial Analysis
Deborah E. Savage, Ph.D.
Tellus Institute, Boston, MA
        The Cash Flow Concept
        The Time Value of Money
        Inflation of operating cash flows
        Another important cash flow - Taxes
        Calculating  after-tax cash flows
        Discounting of after-tax cash flows
        Cost of Capital
        Financial Indicators
        What are the potential shortcomings of conventional capital budgeting  practices?
1:20-1:30
Question-and-Answer  Session
Mike Jackson, Moderator
1:30-1:45
Break

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 1:45-2:35
 Total Cost Assessment (TCA)
 Allen L. White and Deborah E. Savage
       • What is Total Cost Assessment (TCA)
       • The importance of a complete cost/savings inventory
       • The importance of accurate cost allocation
       • Cost estimation - how, where, and who?
       • Project time horizon and profitability indicators
2:35-3:10
Lunch Break
3:10-3:50
TCA Examples
Deborah E. Savage
         An example from the pulp and paper industry
         An example from a metal fabrication and finishing firm

             Case Study:
             The Batch  Still Project
             Polaroid  Corporation Freetown Facility, Massachusetts
             Bill Schwalm (Environmental Programs Manufacturing),
             Ken McCarthy, Dennis Pelletier, Walter Dickerson
3:50-4:05
Break
4:05-4:30
Summary and Conclusions
Allen L. White and Deborah  E. Savage
       • Conclusions
       • Barriers to TCA
       • Is the effort to implement TCA worth it?
4:30-5:00           Panel Discussion and
                    Question-and-Ansvver Session

             Moderator: Mike Jackson
             Panel:  Allen L. White and Deborah E. Savage, Tellus Institute
             Bill Schwalm and Peter Braudis, Polaroid Corporation

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       National Technological University - Modern Manufacturing Video Conferencing Series
                    Environmental Cost Accounting and Capital Budgeting
                    July 12, 1995 - 11:15am to 5:00pm Eastern - MC95071201
         Environmental Cost Accounting
              and Capital Budgeting
                   July 12,1995
               11:15am - 5:00pm Eastern
                                      Slld*1
             What Is Environmental
                  Accounting?
                                      SUd«2
           Environmental Accounting

       is the
       • Identification
       • Compilation
       • Analysis
       • Use
       • Reporting of environmental information
                                      SUd»3
1995, Tellus Institute.
Session 1

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        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
             Environmental Accounting
                      Includes
        Material* Accounting

          • toxic materiala uae
          + waatewatar
            generation rate*
          • natural reiource
                             X
Coat Accounting
  e.g-
  • nazardoua waate
    dlapoaal coata
  • regulatory
    compliance coata
  • alia clean-up cost*
                                           Slid* 4
                 Cost Boundaries
              fm Internal Coat Domain —i
                                 I-Full Coata
                 External Coat Domain-J
                                           Slides

           Conventional Company Costs

        • Equipment
         (Planning, Equipment, Installation)
        • Direct Materials
         (Raw Materials, Catalysts, Solvents)
        • Utilities
         (Electricity, Fuel, Water, Steam, Sewerage)
        • Direct Labor
         (Operating, Supervision, Clerical)
        •Waste Management
         (Treatment, Hauling, Disposal)
                                           aid. 6
1995, Tellus Institute.
                                                                Session 1

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         National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12, 1995 -11:15am to 5:00pm Eastern - MC95071201
                 Less Tangible Costs

         • Liability (Superfund, Personal Injury, Property
          Damage)
         • Future Regulatory Compliance Costs (e.g., CAA
          Amendments, CO2)
         • Value Of Marketable Emission Credits (e.g., SOx,
          NOx)
         • Green Product Sales (e.g., Chlorine-Free Paper)
         • Employee Safety And Health Compensation
         • Production Capacity Due To Emission Limits
         • Corporate Image/Market Share
                                            SM*7
                   External Costs

         • Natural Resource Depletion
         • Human Health Impacts
         • Buildings/Infrastructure Impacts
         • Crop Impacts
         • Wetlands
         • Biodiversity
         • Climate Change
                                            Slides
                  Cost Boundaries
                ConventtonaljCompanylCoats
                  Internal Cost Domain —i
                                  r- Full Costs
                  External Cost Domain—I
                                            SlkteS
1995, Tellus Institute.
Session 1

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        National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12,1995 -1 l:15am to 5:00pm Eastern - MC95071201
             Environmental Accounting
               vs. "Other" Accounting
         Environmental materials and cost Information is
         Just part of the larger framework of total
         materials and coat information
         There is often overlap between environmental
         accounting data and other accounting data.
         Therefore, it la not alwaya obvioua which data
         are "environmental'* or "non-environmental."
         The ultimate goal la to ensure that
         environmental accounting information is alwaya
         Included in the larger framework.
                                            SIM* 10
         Environment*! Costs at Amoco'* Yorktown Refinery
        ss a Parcinug* of Optrstlng Costs (Excluding Cruds)
                    71.1V
 TeMEmkonimflM   21.9%
               4J%
               a7%
 •Sulphur ItacoMry    1.1%
 •Product Speculation* 2.7%
| QAdmlnlstraUon     24%
          mtlOm  O2%
 QUilnMnira      13%
               2£%
        Sourac i
              How Can Environmental
           Accounting Benefit Business
                    Operations?
                                           sad.12
1995, Tellus Institute.
                                                                  Session 1

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         National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
           How Environmental Accounting
                 Information Is Used
                       /   \
                      for
                  Internal
             Monitoring &
         Decision-Making
for
External
Communication &
Regulatory
Compliance
                                            SIM* 13
              Environmental Materials
              Accounting Information


         Internal Uses           External USM
            Measurement of
            company progrett
            towards toxics
            use/release reduction
            Performance
            benchmarking
            Identification of
            pollution prevention
            opportunities
   • Regulatory
     compliance
     reporting to
     EPA, state
     agencies
   • Public reporting
     to local
     community,
     customers,
     stockholders
                     1
                                           SIM* 14
                   Environmental
           Cost Accounting Information
                           \
        Internal Uses
          • Process
            costing/product
            pricing
          • Product retention
            and mix decisions
          • Investment
            decision-making

External Uses
 " » Standards or
   compliance
   reporting to the
   SEC, FASB
  • Influence stock
   market's
   perception of the
   firm
                                           SlktolS
1995, Tellus Institute.
                                                                  Session 1

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        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                 Survey Response
         Tracking Environmental Costs Company-Wide
                                        SIM* 16
                    U.S. ERA'S
            Design for the Environment
                  (DfE) Program
                       DfE
       U.S. EPA's DfE program was initiated in 1992.
       DfE's vision is to help business decision-
       m«kcrs integrate environmental concerns into
       cost and performance criteria.
                            Performance
           Decision
                                        Slid* IS
1995, Tellus Institute.
Session 1

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        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                DfE Industry Sectors
         • Aerospace
         • Dry Cleaning
         • Metal Finishing
         • Printed Wiring Board
         • Printing
          Financial Community Approach
        • Insurance Project
        • Finance/Lending Project
        • Accounting/Capital Budgeting Project
                       DfE
         Environmental Accounting Activities

        • Develop, Pilot and Disseminate Analytical
         Tools and Methods
        • Curriculum Development
        • Organizational Barriers and Incentives
        • Facilitate Dialogue
1995, Tellus Institute.
Session 1

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        National Technological University - Modern Manufacturing Video Conferencing Series
                     Environmental Cost Accounting and Capital Budgeting
                     July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
              What Is the Connection
            Between Capital Budgeting
         and Environmental Accounting?
                                         SIM* 22

                Capital Budgeting

        • Capital Budgeting is the decision-making
         process a firm goes through in
         determining how best to invest its
         available funds •
        • Usually, a firm must choose between
         multiple investment options
        • Capital Budgeting teane of many business
         planning efforts that can benefit from good
         environmental accounting
                                         SMI 23

               Capital Budgeting of
              Environmental Projects

        More comprehensive and accurate cost
        information obtained through environmental
        accounting gives a more accurate picture of
        the true costs and savings generated by
        environmental projects
        This levels the playing field so that
        environmental projects can compete for
        scarce investment funds during the capital
        budgeting process
1995, Tellus Institute.
Session 1

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         National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                   Survey Response
                 Capital Budget Pools
                              Separate for
           Separate for all     compliance projects
        environmental projects^
               11%
                     One pool for all capital projects
                              86%
                                            SUdtZS
           The Connection Between Environmental
              Accounting & Capital Budgeting

                Environmental Accounting

          Materials Accounting  Cost Accounting
             /      X           /       X
         Internal    External    Internal   External
         materials
           Info
                Capital Budgeting Process
                                           SUd>26
          Capital Budgeting Is an Internal
                      Process

         • It is important to note that capital
          budgeting is a managerial accounting
          activity
         i Managerial Accounting is the process of
          preparing business information for internal
          audiences, principally for internal
          decision-making
         i Managerial Accounting (and therefore
          capital budgeting) is unregulated and can
          vary widely from firm to firm

                                           SIM* 27
1995, Tellus Institute.
Session 1

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        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                 Capital Budgeting
                at Small Companies

         • The smaller the firm, the more likely that
          the capital budgeting process will be
          informal and ad-hoc, i.e., without formal
          guidelines or regular timing
         i Efforts aimed at assessing and improving
          the capital budgeting procedures at small
          firms must strike a balance between
          ensuring accurate, consistent practices
          and acknowledging the time/effort
          constraints of personnel at typical firms
                      Project
                     Feasibility
                      Analysis
                                          SIM* 29
         How to Decide Between Projects?

        In order to decide

        1)  which potential projects are wise
           investments and
        2) * which combinations of projects is
           affordable during each capital budgeting
           process

        Someone must perform a project feasibility
        analysis for each project

1995, Tellus Institute.
Session 1

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         National Technological University - Modern Manufacturing Video Conferencing Series
                        Environmental Cost Accounting and Capital Budgeting
                        July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
                   Capital Budgeting
                         Options  x
              Project A?
     Project C?
                        Project B?
                                              SI Id. 31
              Project Feasibility Analysis
         A project feasibility analytic ia the assembly,
         analysis, and presentation of data to characterize
         the value of the proposed project to the firm
                Technical
                Analysis
    Financial
    Analysis
                      '  Project   '
                       Justification
                        Qualitative
                      Considerations
                                              SIM. 32
             Capital Budgeting Process
             Project A
          Feasibility Analysis
     Project B
  Feasibility Analysis
         Technical Analysis
         Financial Analysis
         Qualitative Considerations
                Iflcatl
Tscnnical Analysis
Financial Analysis
Qualitative Considerations
            .Justification
                                 Justification
                     Compare Projects
                       Final Decision
1995, Tellus Institute.
                                                                      Session 1

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           National Technological University - Modern Manufacturing Video Conferencing Series

                        Environmental Cost Accounting and Capital Budgeting

                        July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                      In Summary



           Environmental Accounting

                  *
               Capital Budgeting

                      *
                   Feasibility Analysis

                         *
                       Financial Analysis
                                          SUdcM
                                              I

© 1995, Tellus Institute.
Session 1

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       National Technological University - Modern Manufacturing Video Conferencing Series
                    Environmental Cost Accounting and Capital Budgeting
                    July 12, 1995 - 1 l:15am to 5.:00pm Eastern - MC95071201
                Basic Concepts of
            Project Financial Analysis
             The Cash Flow Concept

        The Cash Flow Concept is a common
        management planning tool.
        It differentiates between

           costs ^ cash outflows
        and
           revenues/savings =3 cash inflows
                                      SllctoS
Types of Cash Flows
Outflow Inflow
One-Time
Annual
Other
Initial
Capital
Cost
Operating
Costs
& Taxes
Working
Capital
Equipment
Salvage
Value
Operating
Savings
& Revenues
Working
Capital
Sttd«4 1
1995, Tellus Institute.
Session 2

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         National Technological University - Modern Manufacturing Video Conferencing Series
                        Environmental Cost Accounting and Capital Budgeting
                        July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                   Analysis Structure

         There are two basic ways to structure a
         project financial analysis
            1) Stand-Alone Analysis
              Considers only the cash flows of the
              proposed project
            2) Incremental Analysis
              Compares the cash flows of the
              proposed project to the "business as
              usual" cash flows
                                              SlkfeS
          Project Cash Rows: Stand-Alone Analysis
                 e.g., for a new product line
Initial
Capital

C°*t
**•
                           Salvage Value
                              CMh
                            Inflows
                    Cash
                    Outflow*
                   11        1
                   M        T
                 Annual       Tax
         purchase operating
                 Cost* e.g.,
                 materials, tabor
          Annual
          Revenue*
          e.g., from
          product
          sale*
                             Working
                             Capital
          Project Cash Flows: Incremental Analysis
         e.g., for modification of an existing process
       Initial
       Capital  a
       Coat
       e.g.,
       equipment
       purchase
                             Cash
                            Inflows
          Cash
          Outflows
       Annual
       Incremental
       Operating Coats
       e.g., Increased
       utility costs
Tax
Annual
Incremental
Savings
e.g., reduced
waste
disposal costs

Working
Capital
                                             Sild«7
1995, Tellus Institute.
                                                                                        Session 2

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        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
           Incremental Analysis Example

         • Many environmental projects are
          worthwhile because project
          implementation reduces annual operating
          costs when compared to "business as
          usual"
         i An incremental analysis example of a
          project from the pulp and paper industry
          follows: The White Water/Fiber Reuse
          Project
                                           SIMM
                Specialty Paper Mill

         i Manufactures 200 tons/year of uncoated
          and coated fine papers
         • Coating is a latex (non-solvent)
          formulation containing clay, styrene
          butadiene, starch, and polymers
         i As a sheet of paper travels across the
          paper machine, a mixture of water and
          filler (i.e., "Whitewater") and residual fiber
          drains off into a collection system
                                           SIMS
         White Water/Fiber Reuse Project

        Current Conditions
        • 2 Paper Machines Share One White Water
         System
        • One Machine Has A Dedicated Saveall

        Problems
        * White Water From Two Machines Often
         Incompatible
        • White Water Is Sewered - Loss Of Fiber,
         Filler, Water
                                           Slid* 10
1995, Tellus Institute.
Session 2

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          National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
           White Water/Fiber Reuse Project
          Proposed Solutions
          • Separate White Water Systems, And
          • Install Dedicated Saveall For Second
           Machine
          Benefits
          • Recovery And Reuse Of Fiber And Filler
          • Recovery And Reuse Of Water
                                          Slid* 11
WW/Fiber Reuse Project
Cashflows: Incremental Analysis
Ont-tlm* Annual
Capital Coats Operating Coats
Bustntss
As
Usual
WW/Fltur
Riun
Project

0


$1,469,404
*

$799,940


$449.250

A
I«UI«I **«•»•

> Annual
lncr« mental
C«U!MM» —
savings s
$350,690
4
Annual
Outflow
SIM. 12












Cash
Inflows
Time I Y
WW/Flber Reuse Project
Cash Flow Timing
Annual Incremental Savings
I3iO,690 5350,690 $350,690 $350^90 $350,690
-n~i^~i
Etc.
\t * * * *
_ . ^v Annual Tax Payments
cash ^ _ ,. , _ .
Outflows fS1^^

Project Lifetime
Slid* 13
© 1995, Tellus Institute.
Session 2

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        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 - 11:15am to 5:00pm Eastern - MC95071201
               Generic Cash Flow Timing
                 Incremental Analysis

       Ca8h   Annual Incremental Savings  Working Capital
       Inflows  •    I     I     I     , I Salvage Value

      Time I
            v«ar
      Zaro
       r
       casn     Annual Tax Payments
       Outflows

          f Working Capital
          Capital Cost
                                           SHU* 14
                  Working Capital

        Working Capital is the total value of goods
        and money necessary to maintain project
        operations
        It includes items such as:
          • Raw Materials Inventory
          • Product Inventory
          • Accounts Payable/Receivable
          • Cash-On-Hand
                                           SIM* IS
             Timing of Working Capital
        Cash                 Sale of Inventory
        Inflows                           j
       Time H vur
       Zero!	1
        Cash
        Outflows
 End
  of
Project
           e.g. Purchase of Raw Materials Inventory
                                          SlktolE
1995, Tellus Institute.
                                                     Session 2

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       National Technological University - Modern Manufacturing Video Conferencing Series
                    Environmental Cost Accounting and Capital Budgeting
                    July 12,1995 - 11:15am to 5:00pm Eastern - MC95071201
Salvage Value
Salvage Value Is the resale value of
equipment at the end of the project's
lifetime.
Cash Sale of Equipment
Inflows 1
Tlmegy«rQ Bill
Zero 0 ,,'fl,, 2B 3H 4q 	 	 5B
Cash
Outflows
End
of
Project
SUttolT
                     The
             Time Value of Money
           The Time Value of Money
       A dollar today is worth more to you than a
       dollar next year, because of
        • Inflation
        • Investment Opportunity
1995, Tellus Institute.
Session 2

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        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 - 1 l:15am to 5:00pmEastern - MC95071201
                      Inflation

         Money loses purchasing power over time as
         product/service prices rise, so
         A dollar today can buy more than a dollar
         next year.
                     Inflation
        Cup of coffee        Cup of coffee costs
        costs S1 now        $1.05 a year from now
              Investment Opportunity

        A dollar that you invest today will bring you
        more than a dollar next year-having the
        dollar now provides you with an investment
        opportunity
       Investing
        $1 now
 Gives you
• $1.10 a year
 from now
                    interest, or
                "return on investment
                                         SIM* 21
Cash
inflows
Time v
Zero , 	
\
WW/Fiber Reuse Project
Cash Flow Timing
Annual Incremental Savings
$350,690 $350,690 $350,690 $350,690 $350,690
ur I D I E p.
I { { 1 * l
^y Annual Tax Payments
Capital Cost
= $1,469,404
Project Lifetime
1995, Tellus Institute.
                                                       Session 2

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         National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12,  1995 -1 l:15am to 5:00pm Eastern - MC95071201
            Cash Flows In Different Years

         In order to accurately estimate cash flows
         occurring in different years and then use
         that information in characterizing project
         profitability, you need to adjust the cash
         flows for
         1)  Inflation • using an inflation rate
         and
         2)  Investment Opportunity-using a
            discount rate
                     Inflation of
               Operating Cash Flows
                                           8UdtZ4
               Adjusting for Inflation
        Future Valuen= Present Value • (1 + t)n

            t             t          \
        The value of
        tho cash flow
         In year n,
        i.e., n years
        after project
          start-up
The value of
  the cash
  flow at
"Time Zero,"
   i.e., at
  project
  start-up
  The
inflation
  rate
                                          SUd*25
1995, Tellus Institute.
                                                                      Session 2

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        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12,  1995 - 1 l:15am to 5:00pm Eastern - MC95071201
             A Simple Inflation Example
         A project implemented by a firm allows
         manufacture of a new product, which will
         bring in annual revenues of $10,000
         (estimated at project start-up).
         Adjusting for an annual inflation rate of 3%,
         what will the revenues be during the fifth
         year after project start-up?
          Future Values = Present Value • (1 + .03)5
                     = $10,000- (1.03)5
                     =611,5931
                                         SIM* 26
WW/Fiber Reuse Project: Adjustment of
Operating Cash Flows for Inflation (5%)
Future Value
Present Value of Cash Flows
of Cash Flows Inflation (In year
Year (Time Zero) * Factor = occurring)
0 -$1,469,404
1 $350,690
2 $350,690
3 $350,690
4 $350,690
5 $350,690
(1 + JOS)" = 1.0
(1 + JOSy
(1 + JOSf
(1 + JOSf
(1 + JOS?
(1 + JOSf
• $1,469,404
$368,225
$386,636
$405,968
$426,266
$447,579
Slid! 27
I





          Another Important Cash Flow -
                      Taxes
                                         SIM* 21
1995, Tellus Institute.
Session 2

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         National Technological University - Modem Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12, 1995 - 11:15am to 5:00pm Eastern - MC95071201
                    Tax Payment


         Depending on a facility's location, a firm
         may have to pay federal, state, and local
         taxes on earnings generated by a project


          Tax Payment = Tax Rate x Taxable Income
                                           SUdtit
                   Taxable Income

         The lower the taxable income from a project,
         the lower the tax payment
         One potentially significant way of reducing
         taxable income is to deduct equipment
         depreciation costs from the project's annual
         total cash flow.
           C*sh Inflow (e.g., revenues, salvage value)
          - Cash outflow (e.g., operating costs)
          - Tax depredation	
          * Taxable Income
                    Depreciation

        Depreciation is the loss in value of a
        physical asset (e.g., a piece of equipment)
        as the asset ages.
        This loss in value can occur for a number of
        reasons, including physical deterioration,
        technological obsolescence, etc.
1995, Tellus Institute.
Session 2

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           National Technological University - Modern Manufacturing Video Conferencing Series
                         Environmental Cost Accounting and Capital Budgeting
                         July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                     Tax Depreciation

            The Internal Revenue Service (IRS) allows
            companies to deduct the cost of a (one-time)
            equipment purchase over a period of years
            that approximates the equipment lifetime.
            The IRS specifies various property types
            and lifetimes for tax depreciation purposes.
                                              SIM. 32
                  Depreciation Periods

           Type of Property       Depreciation Period
           Automobiles, office   —————.
           machinery, computers
           Office equipment,
           most manufacturing
           equipment
           Buildings and real
           estate
5 years
7 years
                                31.5 or 39 years
                                              SlktaSS
                 Depreciation Methods

           There are a number of depreciation methods
           (i.e., depreciation equations) for calculating
           equipment depreciation over the
           equipment's lifetime.
           However, for tax depreciation purposes, the
           IRS specifies several acceptable methods:
            • Straight Line (SL)
            • Double Declining Balance/SL (DDB/SL)
            • 150% Declining Balance/SL (1.5DB/SL)
                                             Slid* 34
S) 1995, Tellus Institute.
                                                            Session 2

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         National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12,  1995 - 1 l:15am to 5:00pm Eastern - MC95071201
           A Simple Tax Depreciation Example
         Straight Une (SL) Tax Depreciation:
           The annual tax       Original Equipment Coat
                             Depreciation Period
depreciation amount
         For a $7000 place of manufacturing equipment, with
         a correapondlng depreciation period of 7 years
          annual tax
          depreciation
             57000
              7
  51000/year
 f or years 1 -7
of equipment uae
                                           Slid* 35
WW/Fiber Reuse Project
Tax Calculation
YMT
R*v*nue*
+ Operating
(Co«tiys*v
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           National Technological University - Modem Manufacturing Video Conferencing Series
                         Environmental Cost Accounting and Capital Budgeting
                         July 12, 1995 - ll:15am to 5:00pm Eastern - MC95071201
                   After-Tax Cash Flows
            The After-Tax Cash Flow (ATCF) for each
            year of the project lifetime should take into
            account all of the cash inflows and outflows
            generated by the project:
              • Initial Investment Costs
              • Annual Revenues
              • Annual Operating Costs/Savings
              • Annual Taxes
              • Working Capital
              • Equipment Salvage Value
                                              SIM*3S
                 WW/Fiber Reuse Project
                  After-Tax Cash Flows
I
          Y**r            01-2345.
          RmnuM             00000
          » Operating
           (CtttoVSnfngi      , 3CU25 316,836 40SJ6a 426368  447,579
          • Tin*           -CU22 • K,735-10U24-119,402-U4419
          • Inmliimil  -1.4ra.404
          * Working Capitol     0
          * S*h)»9*V»lu«	'	
          AIUr-TuCuh  -1,468,404 +299,303 4299J01 +302,444 +306,774 +312.760
           Flow (ATCF)
                                              SIM* 39

                       Discounting
                 of After-Tax Cash Flows
                                              SIM* 40

© 1995, Tellus Institute.
                                            Session 2

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         National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12, 1995 - 11:1 Sam to 5:00pm Eastern - MC95071201
               Investment Opportunity

         At any given time, a company usually has
         multiple opportunities for investing its
         capital.
         When the firm decides to invest in a
         particular project, the firm is, in effect,
         giving up other potential investment
         opportunities that could also be profitable.
                                           SIM* 41
           Opportunity Cost and Discount
                        Rate

         The cost of turning down the alternate
         investment opportunities is reflected in
         project financial analyses by adjustment of
         the cash flow using a "discount rate."
         A company's discount rate can be viewed as
         the rate of return that the company expects
         from an average risk investment
                                           SIM* 42
          When to use the Discount Rate

        As an illustration, take a look ahead to:
        Net Present Value (NPV), a "profitability
        indicator," i.e., a number that characterizes
        the financial consequences of an
        investment

        NPV s The sum of the discounted cash
              inflows and outflows over the lifetime
              of a project
1995, Tellus Institute.
Session 2

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        National Technological University - Modern Manufacturing Video Conferencing Series
                     Environmental Cost Accounting and Capital Budgeting
                     July 12,1995 - 11:15am to 5:00pm Eastern - MC95071201
WW/Fiber Reuse Project


Year
0
1
2
3
4
5


NPV Calculation?
After-Tax
Cash Flows
• $1 ,469,404 Time 0 dollars
+299,303 Year 1 dollars
+299,901 Year 2 dollars
+302,444 Year 3 dollars
+306,774 Year 4 dollars
+312,760 Year 5 dollars
NPV, = SUM = 7?




In order to
add up these
project cash
flows, the
future year $
must be
discounted
back to
TtmeOS

SIM* 44
             Use of the Discount Rate
        The company's discount rate (d) (i.e., the
        rate of return expected on investments) can
        be used to convert future year dollars to
        time 0 dollars.
            Present value =
                         Future Value..
                           (1+d)n
                  Discount rate = d

            Discount factor =	
                         (1+d)n
               n = future year of interest
                                        SIM* 45

WW/Fiber Reuse Project Discounted Cash Flows
Discount Discounted
After-Tax Factor After-Tax
Year Cash Flows * %*-i'}" = Cash Flows
0 -$1,469,404
1 + $299,303
2 + $299,901
3 + $302,444
4 + $306,774
5 + $312,760
%..*}• = 0-862
>6 *.«>* = 0-743
^,.,,^ = 0.641
J^.,,,4 = 0.552
XI*.")53 °-476
- $1,469,404
$258,020
$222,875
$193,763
$169,429
$148,909
|NPV5 = - $476,408 1
Time 0 $ ]




1995, Tellus Institute.
Session 2

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        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201

                   Cost of Capital
                                          SUd*47

                 Sources of Capital
        A company can have several sources of
        capital S for investment These sources fall
        into two broad categories:
         Equity Capital
         Cash on-hand
         Stockholder funds
Debt Capital
Bank loans
Bondholder funds
        Each source of capital has an associated
        cost, e.g., the interest paid to a bank for a
        loan

                  Cost of Capital

        Rather than trying to identify the exact
        source of capital (and its associated cost)
        for each individual project, the firm usually
        develops a single "Weighted Average Cost
        of Capital" (WACC) that characterizes the
        sources and cost of capital to the company
        as a whole.
                                          SHd*4B
1995, Tellus Institute.
                                                                 Session 2


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         National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12, 1995 -11:15am to 5:00pm Eastern - MC95071201
           Discount Rate = Cost of Capital

         The Discount Rate used by a firm to
         discount the cash flows in a project financial
         analysis is usually the firm's WACC, often
         simply referred to as the firm's Cost of
         Capital.
         In »um, Discount Rate = Coat of Capital
         or
         Rate of Return Expected
         on a Project of Average
         Risk
Weighted Average
Cost of Capital to
the Firm
                                            'SIM* SO
           How to Obtain a Cost of Capital

         A company may or may not be able to
         provide an estimate for its cost of capital
           • Large firms usually have an estimate,
            but may consider It to be confidential
            business information
           • Small firms may not have an estimate at
            all
         There are methods for calculating an
         approximate cost of capital for a firm
                                            Slid* 51
                Sensitivity Analysis

        In the absence of a reliable estimate of a
        company's cost of capital, the best
        approach is to do the financial analysis with
        several reasonable values, to illustrate a
        corresponding range of results.
        This type of sensitivity analysis can also be
        done if other data in the analysis are
        uncertain.
                                            Slid. 52
1995, Tellus Institute.
                                                                Session 2

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        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
              And What About Loans?

         It la important to note that principal and
         Interest payments from loans are not
         explicitly included in a project's discounted
         cash flow analysis.
         This is because the discount rate, i.e., the
         company's weighted average cost of capital,
         already includes consideration of loans (a
         type of debt capital) taken by the firm.
                                           SIM* S3
                      Financial
                     Indicators
                Financial Indicators

        A financial indicator, or "profitability
        indicator" is a single number that is
        calculated for characterization of project
        profitability in a concise, understandable
        form.
          Common examples are:
            Simple Payback
            Net Present Value (NPV)
            Internal Rate of Return (IRR)
                                          SUd*S5
1995, TeUus Institute.
Session 2

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       National Technological University — Modern Manufacturing Video Conferencing Series
                    Environmental Cost Accounting and Capital Budgeting
                    July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
             What Are The Potential
          Shortcomings of Conventional
          Capital Budgeting Practices?
                                       Slid. 66

            Potential Shortcomings of
             Conventional Practices
        • Incomplete Cost/Savings Inventory
        • Misallocation of Costs
        • Inadequate Time Horizon
        • Inappropriate Financial Indicators
                                       Slid. 57
1995, Tellus Institute.
Session 2

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-------
        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12,  1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                      What Is
              Total Cost Assessment
                      (TCA)?
                                          Slldtt
                       TCA

        Total Cost Assessment (TCA) is a generic
        term for the long-term, comprehensive
        analysis of the internal costs and savings of
        pollution prevention and other
        envirdnmental projects
                                          Slid. 2
          Costly Environmental Projects?


        Interest in TCA and related approaches was
        originally triggered by the observation that
        environmental projects historically have
        been viewed as profit-sustaining
        (compliance/maintenance) projects, rather
        than as potential profit-adding projects.
                                         Slid* 3
1995, Tellus Institute.
Session 3

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        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12,1995 - 1 l:15am to 5:00pm Eastern - MC95071201
           TCA for Environmental Projects

          A TCA approach can be used for the
          financial analysis of any type of project.
          However, TCA is particularly useful for
          projects with significant environmental
          components because environmental
          projects tend to involve costs and savings
          typically neglected by conventional
          practices.
                                          SIM* 4

                  Elements of TCA

        TCA corrects some of the flaws of
        conventional financial analysis practices by
        incorporating:
          •A comprehensive cost/savings
            Inventory
          • Appropriate cost allocation
          • Longer analysis time horizons
          • Suitable profitability indicators
                                          sadts
                 The Importance
                  of a Complete
              Cost/Savings Inventory
                                         SIM* 6
1995, Tellus Institute.
Session 3

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          National Technological University - Modern Manufacturing Video Conferencing Series
                         Environmental Cost Accounting and Capital Budgeting
                         July 12,  1995 -1 l:15am to 5:00pm Eastern - MC95071201
                 Cost/Savings Inventory
          There are numerous potential costs and
          savings associated with industrial projects.
          Some cost and savings are specifically
          environmental (e.g., waste disposal costs)
          and some are more generic (e.g., operating
          labor).
                                               Slid. 7
                 Major Cost
                Initial Costs
          i Buildings and Land
          i Purchased Equipment '
          i Materials
          i Utility Systems and
           Connections
          i Planning/Engineering
          i Site Preparation
          i Construction/Installation
          i Start-up/Training
          i Permitting
          i Working Capital
          i Contingency
Categories
     Recurring Costs
  • Materials
  • Labor and Supervision
  • Utilities
  • Waste Management
  • Regulatory
   Compliance
  • Insurance
  • Future Liability
  • Revenues

                 SJktot
              Which Costs Are Typically
                      Neglected?
            Less Likely To Be
               Neglected
         • One-Time Investment
          Costs
         • Direct Costs
         • Certain Costs
         • Short-Term Costs
         • Easily Quantifiable
          Costs
   More Likely To Be
      Neglected
• 'Annual, Recurring
 Costs
• Indirect, Hidden Costs
• Uncertain,
 Probabilistic Costs
• Long-Term Costs
• Dlfficult-To-Quantify
                              Costs
                                              Slid* 8
1995, Tellus Institute.
                                                                      Session 3

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         National Technological University - Modern Manufacturing Video Conferencing Series
                        Environmental Cost Accounting and Capital Budgeting
                        July 12,1995 - ll:15am to 5:00pm Eastern - MC95071201
             Examples of Costs/Savings
                  Typically Included
                 Investment Costg
• Purchased equipment
• Construction/Installation

Annual. Bacurrlno Costs
• Raw material*
• Operating labor
• Waste hauling and disposal

                                     Direct, Certain
                                        Easily
                                      Quantifiable
                                             aid. 10

               Examples of Costs/Savings
                  Typically Neglected
        Qno-TlmB Investment Coati
        • Start-up/training
        • Permitting
        Annual. Recurring Costs
        • Regulatory compliance
        • Green market revenues
        • Liability
              ues V.
                                    Indirect
                                    Hidden
                     Uncertain, Probabilistic
                      Difficult-To-Quantify
                         Long-Term
                                             Slid. 11
                     Survey Response
          Costs Normally Considered In Financial Analysis
                                            SUd«12
1995, Tellus Institute.
                                                                                       Session 3

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      National Technological University - Modern Manufacturing Video Conferencing Series
                 Environmental Cost Accounting and Capital Budgeting
                 July 12, 1995 - 11:15am to 5:00pm Eastern - MC95071201
                            Survey Response
         Costs Normally Considered in Financial Analysis
                                                                   Percent
                                                                    who
                                                                  consider
                                                1
Cost Item
     >n-
  US
    Energy costs

    i l^ffMttM»»^!«	
    Licensing/permitting


    Production efficiency/yield
    ^^aa^^^^&istt^^^
    On-site hazardous waste handling (storage, labeling)
    Employee safety/health compensation claims
                                       78
                                       76
                                       74
                                       70
                                       69
    Source: Environmental Capital Budgeting Survey . Tellus Institute, for U.S. EPA, June 1995
                                                                     Slide 12
(Larger size to show detail)
1995, Tellus Institute.
                                        Session 3

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          National Technological University - Modern Manufacturing Video Conferencing Series
                           Environmental Cost Accounting and Capital Budgeting
                           July 12,  1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                              (cent.)

                          Co*tK»m
          Fuort ragtutoryccrrcMnctcocts
          |T«* eon •Mrfc tHHtiHimSfByf.
          ttumiic
               * costs
          BSS*H!
          FKftntiiifun
                lyuryoirni	
                t>L6<»rhrmn»o«na»fT
           rtOUwScy ot plirt shutdown
              '
          Prcptftyoimlig*
                  .ttitttSSSI?
           laoxBJ rvcourca Ovnagt
           "itiiiiitbor*	
            •foT*>
yy^,|-ry^»|,tnTttai'i'""' ••'••••T'™"™"
e*ytiK!^T*8^i»M»»gs*»5ijai
SI)M oTcrnnrontrarially frwridrjiqrMri pro
«*«-3*S-Efer*,-->i
                              **n products
                                                   50
                                                    Slid. 13
                        Survey Response
          Cost Items for which Specific Values Are Calculated
                 Among Those Who "Consider* Each Cost
                          Cattlutn
         fiaais
         «*w?
                «**si$ffi
                !b?i
                f»jl
                    •anut
          «*«BS«
         ^*t!«sr^
         On to« ftir •msuc
          n to« or •m&uon conerots
         jpn'iar
         l^^^yg-vasL^SL'SSS!
         SuH tritrmg lor trivironnnnlifcornpliiric*
         fOkn naUlfciy'tgrnphiioi ebi>i?*^.^--i£
         Kiutl mourc* flirrjje ^ 	
         )tepw>lflteiOoi'*"nt«0 KM"*""
         Cotpona ITU j« iH«cu
                                        who
                                      calculMi
                                                  75
                                                -!*»t%g-«^I'

                                                -^—

                    :*n-it*j,n~tS*nT,.-!,r,?,i,u«*r.iotvi.fr/^tu*\m
                                                   SUttalS
1995, Tellus Institute.
                                                                                                     Session 3

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       National Technological University - Modern Manufacturing Video Conferencing Series
                    Environmental Cost Accounting and Capital Budgeting
                    July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
      (cont.)

Cost Item
       Future regulatory compliance costs
       Environmental penalties/fines
       i^.^	>*• ««*- ,-t*..in.......!.*wz*~..*
-------
      National Technological University - Modern Manufacturing Video Conferencing Series
                Environmental Cost Accounting and Capital Budgeting
                July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                          Survey Response
      Cost Items for which Specific Values Are Calculated
                Among Those Who "Consider" Each Cost
                             Cost Item
Energy costs

Marketable by-products
Ilii^MgSiintMS	
Qn-site air/wastewater/hazardous waste testing/monitoring

    insurance costs
    On site air emission controls
                            _
                                                       Percent
                                                        who
                                                      calculate
                                                            92
                                                            89
                                                            84
                                                        84
                                                        81
     Source: Environmental Capital Budgeting Survey . Tellus Institute, for U.S. EPA, June 1995

                                                                 Slide 14
 (Larger size to show detail)
1995, Tellus Institute.
                                                              Session 3

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         National Technological University - Modern Manufacturing Video Conferencing Series
                     Environmental Cost Accounting and Capital Budgeting
                     July 12, 1995 - 11:15am to 5:00pm Eastern - MC95071201
                                         (cont.)

                                    Cost Item
Environmental staff labor time
        Off-site hazardous waste transport

        On-site hazardous waste handling (storage, labeling)
        Sales of environmentally friendly/green products
        Manifesting for off-site hazardous waste transport
        Employee safety/health compensation claims                         63

        Staff training for environmental compliance                           59
        Natural resource damage                                            55
        *-~™ -~"~	•• • • -	—*"-- •""••—"-	-•	.—.....—.,„	„,—	.„.	r (((fffffftttottftjafrj-K'ffH-uY, ffiwrri iTffi^iiTriiii 11 il irmiYi imWf -^                 ZfnntMiii-iwirilii111 iMft
        Corporate image effects                                             26

        Source: Environmental Capital Budgeting Survey .  Tellus Institute, for U.S. EPA, June 1995
                                                                              Slide 15
                                                                 Percent
                                                                   who
                                                                 calculate
                                                                            79
                                                                    77
                                                                    75
                                                                    73
                                                                    71
   (Larger size to show detail)
© 1995, Tellus Institute.
                                                                       Session 3

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        National Technological University - Modem Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 - ll:15am to 5:00pm Eastern - MC95071201
            Why Are Costs Neglected?

          Perception that
            _some coits ire not relevant
            —some coiu are not significant enough to
             qualify
            _iomo com aro too difficult to quantify
          Environmental coata are often
            -hidden
            ..assigned to overhead accounta
                                           SIM* 16

                    Survey Response
           Barriers to Quantifying Suparfund Liability
        I
                    Barriers  HHi,  «••«••  UtHS
                                 tfc»UJ.E?A.l—.IWi
                                           SIM* 17

                  Survey Response
          How Superfund Effects Are Handled
                        n=137
       Do not consider
       Superfund effects
            64%
                           Both qua), and quant
                                16%
Specific $ value
    8%
Qualitatively only
   12%
                           ; T«U«iUiMi««. farm. ETA. *u«l»95
                                            Slid* II
1995, Tellus Institute.
                                                              Session 3

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             National Technological University - Modern Manufacturing Video Conferencing Series
                             Environmental Cost Accounting and Capital Budgeting
                             July 12, 1995 - 11:15am to 5:00pm Eastern - MC95071201
                      Some Environmental Costs
                  Hidden in a Typical Cost Statement
                                       ue of lost inputs
                                    Incremental cost of
                                    •ubstltuta*
                                   •environmental cost*
                                    of Intermediate*
                                    environmental product
                                    specification*
             Soire:Gn«aL>d>d>i>ij>a»ponleEan
               Work) Reran* luciuie. M.y. 1995
                                                     SIM* 18
                     Some Environmental Costs
                  Hidden in a Typical Cost Statement
              Variable Coaia
              Raw Materials
              Intermediates
              Additives
              UHttiac,
              Direct L
              Pacfcigmg
              Wastmmier Treatment
environmental coat*
of on-*Ke power
generation
water, power for
environmental
management

             SOUKC: Gram Ledfen: Cue Sudia a Coqwrac Eat
              WoU Roouna Uuuiu. Mir. 1995
                                                    SIM* 20

                     Some Environmental Costs
                 Hidden in a Typical Cost Statement
              vanaow coan
              Raw Materials
              Intermediates
              Additives
              Utilities
              Direct Labor
              Packaging

                                  eo*t of environmental
                                  labeling
                                 •take-back of used
                                  packaging
            Source- Green Ledger* Cue Sludw* in Cofponle Eamtnuneaul Acctxtatiag
              Wot Id Renuicu lDUinile.Miy.l99S
                                                    Slid* 21

5) 1995, Tellus Institute.
                                                                           Session 3

-------
         National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12,  1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                 Some Environmental Costs
             Hidden in a Typical Cost Statement
         RxMCeca
         Scctrraor
         Fbtd Labor
         Dtpracuion
         (Xvwaul
         O*nwal S*nv«
         Admnfmton
                     . Miy. I*M
recordkeeplng and
reporting
Uma spent on
compliance
monitoring
environmentally-
related maintenance
                                             SIM* 22
                Some Environmental Costs
             Hidden in a Typical Cost Statement
         nx«ICe*l»
         Suxmccr
         Fted Labor
         Otoraoaaon
         OMtianilOnctiud
         Ototnl S
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            National Technological University - Modern Manufacturing Video Conferencing Series
                          Environmental Cost Accounting and Capital Budgeting
                          July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                 How To Use The Inventory

             i Consider tailoring the generic
              cost/savings inventory for routine use with
              specific industry sectors and/or for
              specific process/project types.
             i Use the inventory as a checklist in
              determining if each item on the list is
              • not relevant to the project
              • relevant but quantitatively insignificant
              • relevant and quantitatively significant
              • relevant but not quantifiable
                                              SUd.25
             To Quantify Or Not To Quantify?

           How do you know If a relevant cost or
           savings is quantitatively significant before
           you go ahead and quantify it?
           You don't
           Try to do at least a rough, first-cut estimate
           of all quantifiable costs - then decide
           whether or not refining the estimate is worth
           the effort.
                                              SIM* 26
                     The Importance
              of Accurate Cost Allocation
                                             SIM* 27
© 1995, Tellus Institute.
Session 3

-------
        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 -  1 l:15am to 5:00pm Eastern - MC95071201
               Initial Cost Assignment

         In general, costs within an industrial firm are
         either
           •assigned directly to the process,
            product, or project directly responsible
            for generating the cost
         or
           •first assigned to facility, division, or
            company overhead accounts

                                          SIM* 21

Survey Ffosponsa - IntUi
ta^^uiyrudU^1 """'***"•'

KaysSLassiss^


tt'l>li...l»-|^" 	 "I""TJ
t)*i.-ujii 111. • -. i. «-.'sr~~~
r"-l^--*2!i^-f^«tfa?™™ -i-a



1 Assignment of Cost*
»*•*» IJ»^m i*a«r» *•»•»
»••» VWMi
«»<|-,>»a.,a;.i. i.ili,.M,-i t .mi


ii-~^5=--r^.g5jftgg;*2ff^f
"

^•-i.-rr1^ -i J""yi"-ffa!3l>
-,.-*• '..•f,-'.?si*;",€"fei-^s
IMr =«LL •
Ti«nli«i«M.A.J«««l9M Slid* 29
                  Cost Allocation

         Costs initially assigned to overhead
         accounts are usually allocated back to
         processes, products, or projects using an
         allocation basis such as
           •materials use
           •production volume
           • machine hours
           • labor hours
                                          SIM* 30
1995, Tellus Institute.
Session 3

-------
        National Technological University - Modern Manufacturing Video Conferencing Series
                     Environmental Cost Accounting and Capital Budgeting
                     July 12, 1995 - ll:15am to 5:00pm Eastern - MC95071201
         Survey Response - Initial Assignment of Costs
             Environmental staff labortime
             Reporting to government agencies

             Insurance costs
             On-site air/wastewater/hazardous waste
             testing and monitoring
             Manifesting for off-site hazardous waste
             transport
             On-site waste water pre-
             treatment/treatment/disposal
             On-site hazardous waste handling (e.g.
             storage, labeling)
                                               Always to   Usually to   Usually to   Always to
                                               overhead   overhead   product/    product/
                                                                 process    process
                                                 74 ^- .
                                                 68
                                                          26
58
         23
12
58
         29
Source: Environmental Capital Budgeting Survey . Tellus Institute, for U.S. EPA, June 1995    Slide 29
 (Larger size to show detail)
1995, Tellus Institute.
                                    Session 3

-------
          National Technological University - Modem Manufacturing Video Conferencing Series
                         Environmental Cost Accounting and Capital Budgeting
                         July 12, 1995 -1 l:15am to 5:00pmEastern - MC95071201
                       Survey Rotponae
          Bull (or Allocating Coat* to Product/ProceeMS (ram Overhead
                    (n»S8, two answer* accepted)
                                              SIMt31
          Example of Conventional Cost Allocation
         Overhead
         Plant      '
         Management
         Maintenance
         Process
         Utilities
         Environmental
         R»aul«tory
         Compliance  j
   Assigned Directly
Process X labor costs
    material* costs
 waste disposal costs
   product revenues


Process Y tabor costs
    materials costs
 waste disposal costs
   product revenues
            Allocation Basis Is Important

         In the previous example, plant management,
         maintenance, process utilities, and
         environmental regulatory compliance are
         allocated from overhead to the two
         manufacturing processes on the basis of
         production volume.
         Is this reasonable?
                                             SIM133
1995, Tellus Institute.
                                                               Session 3

-------
            National Technological University - Modern Manufacturing Video Conferencing Series
                          Environmental Cost Accounting and Capital Budgeting
                          July 12,  1995 -1 l:15am to 5:00pm Eastern - MC95071201
              All Processes Are Not Created Equal
            • Process X equipment, the business start-up
              equipment, is much older than the
              equipment for Process Y. Process X,
              therefore, requires much more maintenance
              labor and parts than Process Y.
            • The hazardous waste generated by Process
             X is subject to more environmental
             regulation than the Process Y waste.
            • Process Y, on the other hand, is a high-
             temperature process that requires
             significant heating and cooling capacity.
                                               SIM* 34
              More Realistic Cost Allocation
Overhead Cart
Plant
Management

Maintenance

Proceu Utilities

Environmental
Regulatory
Compliance
                           Procjn x


                           60%

                           80%

                           30%



                           70%
Proca«i V


40%

20%

70%



30%
                                               SIM* 35
              Activity Based Costing (ABC)

           Under Activity Based Costing (ABC), costs
           are allocated to processes, products, or
           projects on the basis of activities with a
           direct relationship to cost generation.
           Use of ABC will not eliminate overhead
           accounts, but will ensure the availability of
           more accurate cost information for
           management decision-making.

s) 1995, Tellus Institute.
                                                            Session 3

-------
         National Technological University - Modern Manufacturing Video Conferencing Series
                        Environmental Cost Accounting and Capital Budgeting
                        July 12,  1995 -1 l:15am to 5:00pm Eastern - MC95071201
               White Water /Fiber Reuse Project
                 Cost Inclusion Comparison
          X«Cost(*) Included
          P « Coitfr) Partially Included
          Capita! Costa
           Purchased Equipment
           Materials (e.g., Piping, Elec.)
           Utility Systems
           Slto Preparation
           Installation (labor)
           Engineering/Contractor
           Start-up/Training
           Contingency
           Permitting
           Working Capital
                                 Company TCA
X
X
X
X
X
X
X
X
X
X
X
X
         Operating Coils
           Direct Costs:
              Raw Materials/Supplies
              Labor
              Revenues - General
              Revenues - By-products
           Indirect Costa:
              Waate Management:
              Utilities:
                Energy
                Water
                Sewerage (POTW)
              Regulatory Compliance
              Insurance
              Future Liability
                                 Company  TCA
P
X
X
X
       X
       X
       X
White Water /Fiber Reuse Project
Cost Summary (Thousands of $)
Company TCA Difference
Capital Costs $1,469 $1,469 $ 0
Operating
Savlngs/(Coits)
•) Raw Materials
Fiber and Filler Loss
Freshwater Treatment
Flocculating Agents
b) Labor
Equipment Operation
c) Utilities
Electricity
Steam
Sewerage
Subtotal


S
s
(S

(S

(5
$
$
5


422
0
29)

3)

107)
0
68
3S1


$
$
(S

(S

($
$
$
S


422
26
29)

3)

34)
393
68
911


S
$
$

$

$
$
$
*


0
26
0

0

141
393
0
seo
SIM* 39
1995, Tellus Institute.
                                                               Session 3

-------
           National Technological University - Modern Manufacturing Video Conferencing Series
                         Environmental Cost Accounting and Capital Budgeting
                         July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                    Cost Estimation -
                  How, Where, and Who
                 Solvent Use Information Flow:
           hi ttw Chnnlal Opwatfen* DhrtsJon of • High-Technology Multtratloiul
                                            SIM* 41
           Who Develops Cost Estimates for
                Environmental Projects?
          Department        | Routinely Involved (%)
          Production/Operations
          Environmental
          Finance/Accounting
          Purchasing
          Legal
          Vendors
          Consultants
          Other
65
64
64
36
20
23
38
13
       Sowcc Envtrommtmtol C*fHlfi Bm4t*tt*g Smrvn, Tellua iflttJlute. for U.S. EPA. June 1995
3 1995, Tellus Institute.
                                                        Session 3

-------
       National Technological University - Modern Manufacturing Video Conferencing Series
                   Environmental Cost Accounting and Capital Budgeting
                   July 12,  1995 -1 l:15am to 5:00pm Eastern - MC95071201
                   Solvent Use Information  Flow:
      in the Chemical Operations Division of a High-Technology Multinational
                             UST Level Gauges
           UST to Building
              Row Meters

                Building
               Production
                  Report
           Reaction Vessel
              Inlet Solvent"
              Row Meters
W          1      ^
  *^     f   > <*
       Material Control,
          Group [1]
^Non-batch Solvent Usage

^Tank Farm Delivery Receipts

 —Solvent Recovery Plant
  Delivery Receipts

            Finance Group
     Material^Report [3]


      'Batch Sheet [2]1
                          Virgin/Recovered
                          Solvent Ratio
                                                           SAF
                                                           Reporting
    VAX
                           )ivision Solvent Use
                         "Audit Spreadsheet

          Omitted Solvent Uses:
          [1] Solvent recovered in the building
          [2] Non-batch solvent usage (clean vessels between batches &
              campaigns; purge solvent lines)
          [3] Deviations from normal solvent procedures
                                                              Reconciliation:
                                                            Division Solvent Use
                                                                              Slide 41
(Larger size to show detail)
1995, Tellus Institute.
                                                        Session 3


-------
        National Technological University — Modern Manufacturing Video Conferencing Series
                        Environmental Cost Accounting and Capital Budgeting
                        July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
           Examples of Sources of Cost Information

         The enctotod table provide! examples of various
         •nvironnwntal cost activities (Activity), the way
         those activities might be defined for determining
         frequency or volume (Cost Driver), the Information
         needed to calculate the costs of the activities
         (Measurement), and the sources of Information
         about the activities (Source).

         Activity  Cost Driver  Measurement  Source
       Some: InpnvMsYourCompMiiivcPMitica: StnUfe wd fiaucul A
       a—.— D—_.. TV...... u-,i,.IMFWHn«.-iUACTTA 1M«
                                              SIM* 43
                Project Time Horizon
             and Profitability Indicators
            Which Time Horizon Is Best?

         • To some extent, the best analysis time
          horizon will be project-specific and will be
          related to factors such as the equipment's
          useful lifetime.
         i In general, the long-term view is best, in
          order to capture all relevant costs/savings.
         i Once the long-term analysis is completed,
          the firm can always use the information
          also to review the short-term benefits of
          the project.
                                              SIM* 45
1995, Tellus Institute.
Session 3

-------
                 EXAMPLES OF SOURCES OF COST INFORMATION

   The following table provides examples of various environmental cost activities (Activity), the
   way those activities might be defined for determining frequency or volume (Cost Driver), the
   information needed to calculate the costs of the activities (Measurement), and the sources of
   information about the activities (Source).
ACTIVITY
Spill/Leak Incident
Reporting
Monitoring
Manifesting
Right-to-Know
Training (in-house)
Labeling
Permitting & Fees
Maintenance &
Repair (Old Equipmt)
Maintenance (new
equipment)
Solvent Disposal
Training Supplies
Protective Equipment
COST DRIVER
Number of Spills
Number of Incidents
Number of Toxics
Number of Processes
using Toxics
Number of Shipments
Number of Sessions
Number of Drums
Shipped Off-Site
Number of Toxics
Number of Gallons or
Lbs.. Discharged
Number of Machines
Number of Machines
Number of Drums
Number of
Employees Trained
Number of Sessions
Number of
Employees
Sq ft protected
MEASUREMENT
Labor Hours
SAveek
Labor Hours
SAveek
Labor Hours -
$/week
$/shipment or $/drum
Labor Hours
$/week
Labor Hours
$/week
$/drum .
Labor Hours
$/week
fees(S/chemical or/gl)
Labor Hours
$/week
spare parts/equipment
$/item
Labor Hours
SAveek
spare parts/equipment
$/item
$/drum or /lb
$/employee
$/session
$/emplovee
$/Sq Ft.'
SOURCE
Engineer Interview
Engineer Interview
Engineer Interview
Manifesting Records
Engineer Interview
Engineering Records
Engineer Interview
Engineer Interview
Accounting Records
Regulatory Documnt
Machine Manufcturer
Vendor
Outside Repair Shop
Machine Manufcturer
Vendor
Engineer Interview
Accounting Records
Engineering Records
Engineering Records
Accounting Records
Engineering Records
Accounting Records
            NEWMOA = Northeast Waste Management Officials' Association

            MAOTA = Massachusetts Office of Technical Assistance
Source: Improving Your Competitive Position: Strategic and Financial Assessment of Pollution
Prevention Projects, Training Manual NEWMOA and MAOTA, 1994.
                                                                Session 3 - Page 43a

-------
           National Technological University - Modern Manufacturing Video Conferencing Series
                         Environmental Cost Accounting and Capital Budgeting
                         July 12, 1995 -  1 l:15am to 5:00pm Eastern - MC95071201
                   WW/Fiber Reuse Project
                       Time Horizons
                  Original Company Analysis
           Time Horizon
           5 years

           10 years

           15 years
 NPV5 = - $476,000

     NPV10 = + $48,000 °

I	H-*HNPV1S = + $360,000
             Which Profitability Indicator?

          Recall that there are a number of different
          profitability indicators. These indicators can
          be divided into two broad categories.
          Consider the Time  Does Not Consider the
           Value of Money     Time Value of Mqngy

                NPV          Simple Payback
                IRR
                                           Slid* 47
                  Simple Payback
         Simple Payback is a financial indicator that
         incorporates only information about
               1) the initial investment cost
         and
               2) the resulting annual cash flow,
                 unadjusted for the time value of
                 money
          Simple Payback
            (in years)
     Initial Investment
                          Annual Cash Flow
1995, Tellus Institute.
                                                                                           Session 3

-------
        National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12,1995 - 1 l:15am to 5:00pm Eastern - MC95071201
                    NPVandIRR
         Net Present Value (NPV) and Internal Rate of
         Return (IRR) are more sophisticated financial
         Indicators that consider both the time value of
         money and all future year cash flows.
         NPV * the sum of the discounted cash flows
              over the lifetime of the project, using
              the company's cost of capital as the
              discount rate
         IRR = the discount rate for which NPV = 0,
              over the project lifetime, calculated
              Iterative)/
                                            SIMt48
              Project Adoption Criteria

        Indicator     Adopt the Prolnc! If...
         Simple       Simple payback
        Payback           period

          NPV           NPV > 0
                         company
          IRR     IRR > dltcountrate
                      (coat of capital)
 company
rule of thumb
                                            SlkfcSO
                    Survey Response
          Approval Thresholds for Environmental Projects
            Compared to Non-environmental Projects

                 Higher for env.
                      proj
                      7%
1995, Tellus Institute.
                                                           Session 3

-------
          National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12, 1995- ll:15am to 5:00pm Eastern-MC95071201
                   Profitability indicators
               Advantages and Disadvantages

                  Major Advantage Major Disadvantage
           Simple
           Payback
            NPV
            IBB
Easy to use
Considers TVM
Measures project
scale
Considers TVM
Neglects TVM
Need firm's cost
of capital
Requires an
iterative
calculation
                                           SOOtSl
           Profitability Indicator Summary

         • NPV is generally the most valuable,
          problem-free indicator.
         • Other indicators that consider the time
          value of money, such as IRR, are also
          useful.
         • Payback should be used only for very
          small projects, for a first-cut rough
          screening analysis of more significant
          projects, or to complement NPV/IRR
          information.
                                           Slid. S3
White Water/Fiber Reuse Project
Profitability Analysis
Company Analysis TCA 1
Total Capital Costs
Annual Savings
Financial JndiCfitQrff
Net Present Value - Vein 1-5
Net Present Value - Years 1-10
Net Patent Value -Year* 1-15
Internal Rate of Return - Years 1-5
Internal Rate of Return - Years 1-10
Intern*! Rate of Return - Year* 1-15
Simple Payback (yean)
$1,469
S 351
(S 476)
S 48
S 360
1%
17%
21%
43
$1,469 1
S 911
S 784
$2,074
S2.852
37%
46% I
48% I
1.6 I
SlktoS4 I
1995, Tellus Institute.
Session 3

-------
         National Technological University - Modern Manufacturing Video Conferencing Series
                        Environmental Cost Accounting and Capital Budgeting
                        July 12, 1995 -  11:15am to 5:00pm Eastern - MC95071201
                  Implementation of TCA
                 Summary of Basic Steps

         1) Select • long-term but realistic time horizon
         2) Develop • project-specific cost/savings
           Inventory, using the generic Inventory as a
           guideline. Be aura to consider lass-tangibla and
           out-year Hems.
         3) Develop capital and annual operating coat
           estimates using the project eost/savinga
           Inventory aa a check list. Be aura to consider
           htdden/mlsallocated coats.
         4) Adjust the annual cash flows for Inflation
                                               SIM* IS
         5) Calculate tax paymenta. Be aura to consider the
           depreciation tax break
         6) Calculate tho After-Tax Cash Flows (ATCF)
         7} Calculate the Discounted Cash Rows (DCF)
           using the company's Cost of Capital aa the
           discount rate.
         8} Calculate financial Indicators - NPV and IRR
         8) Qualitatively describe relevant Hems not
           quantified
                                               SUd.B6

1995, Tellus Institute.
Session 3

-------
        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
                  TCA Examples
                   An Example
         from the Pulp and Paper Industry
                                        Slid* 2
            The WW/Fiber Reuse Project
                    Summary
        • Illustrates the application of TCA to a
         single environmental project at a single
         facility
        • TCA revealed some relevant, significant
         annual savings neglected by the
         conventional company analysis
        • The neglected items were:
         • Freshwater treatment chemicals
         • Freshwater pumping and heating
         • Wastewater pumping
1995, Tellus Institute.
Session 4

-------
        National Technological University - Modem Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 -1 l:15ain to 5:00pm Eastern - MC95071201
             The WW/Fiber Reuse Project
                      Summary

         • Inclusion of the previously neglected
          savings more than doubled the annual
          cash flow to the project
         •This resulted in a substantial increase in
          project profitability, both over the short-
          term and the long-term
                    An Example
                       from a
          Metal Fabrication and Finishing
                     Firm (MF3)
                                          SUdlG
          Metal Fabrication and Finishing

                     Firm (MF3)

        • Privately owned
        • 2 Facilities, 200 • 300 employees
        • Major products and customers
          - Computer cabinets for a computer
           manufacturer
          - Office furniture metal components for a
           furniture maker
        • Many environmental efforts at the firm undertaken
         due to customer demand and yrith customer
         assistance
1995, Tellus Institute.
Session 4

-------
             National Technological University - Modern Manufacturing Video Conferencing Series
                            Environmental Cost Accounting and Capital Budgeting
                            July 12, 1995 -  11:1 Sam to 5:00pm Eastern - MC95071201
                   Capital Budgeting at MF3

              • No standard procedure
              • Projects proposed to management on an
               ad-hoc basis
              • Environmental projects handled in the
               same way as other projects
              • Vendors play a key role in project analysis
              • Limited costs/savings quantified
              • Simple payback is the financial indicator
               used
                                                  Sid. 7
                Paint/Water Separator Project

                    Incremental Analysis
            Current Condltlonn
            • A couple of the fabrication and finishing steps
              generate aqueous-based wastes
              • water/ammonia/pigment mixture from flushing
                paint spray guns
              •water-soluble oil waste from matal grinding
                operations
            Problem

            • These wastes currently manifested and shipped
             off-site for incineration. Approximate hauling and
             disposal: S8906/year
                                                 Slid* 8
               Paint/Water Separator Project

            Proposed Solution

            • Installation of a 100-gallon batch system for
             paint/water separation
            • Suitable for both paint waste and oily waste
            • Purchase of an infrared heater to dry and reduce
             volume of filtered sludge
            Benefits

            • Recovery of separated water for recycle or
             sewerage
            • Reduced cost for hauling and Incinerating
             residual wastes, i.e., paint solids and oil fraction
                                                 SIM* 8
3 1995, Tellus Institute.
                                                                                                      Session 4

-------
          National Technological University - Modem Manufacturing Video Conferencing Series
                         Environmental Cost Accounting and Capital Budgeting
                         July 12,  1995 -11:15am to 5:00pm Eastern - MC95071201
                 Paint/Water Separator Project
                  Cost Inclusion Comparison
          X * Coit(i) Includid
          P« Co»t(i) Partially Included

          Capital Coat*
          Purchaaad Equipment
          Material* (e.g., Piping, Elac.)
          Utility Sygtemi
          SIta Preparation
          Installation
          Engineering/Contractor
          Start-up/Training
          Contingency
          Paimlttlng
          Working Capita!
Company TCA
                                               Slid* 10
          Operating Coata
           Direct Coata:
              Raw Matirlalt/Suppllaa
              Waata Olapoaal
              Labor
              Revenues - General
              Revenues - By-producta
           Indirect Coata:
              Waata Management:
                Hauling
                Storage
                Handling
                Waate-and FMa/Taxaa
                Hauling Inaurance
                                 Company  TCA
  X
  P
  X
X
X
X
                                               aw. 11
         Operating Coata (cont)
             Utllltlea:
               Energy
               Water
               Sewerage (POTW)
             Regulatory Compliance
             Inaurance
             Future Uablllty
                                 Company TCA
         X
         X
         X
         X
                                              SIM* 12
1995, Tellus Institute.
                                                                  Session 4

-------
             National Technological University - Modern Manufacturing Video Conferencing Series
                           Environmental Cost Accounting and Capital Budgeting
                           July  12,  1995 -  11:15am to 5:00pm Eastern - MC95071201
Paint/Water Separator Project
Cost Summary
Company
Capital Cost* $19,659
Operating
Savings/(CosU)
a) Raw Materials
b) Labor
e) Waste Disposal Mgmt
d) Utilities
e) Regulatory Compliance
Subtotal
($ 218)
($ 714)
$5,651
($ 136)
$ 0
$4,583
TCA Difference
(TCA-C«*p«y)
$19,733 $ 74 I
($ 218)
($ 714)
$6,135
($ 163)
$ 194
$5,234
$ 0 I
$ 0 1
$ 484 1
(* 27) 1
$ 194 1
$ 651 1
                                                SIM. 13
                   Paint/Water Separator Project
                      Profitability Analysis
                              Company Anatvil« TCA
                                   $19,659  $18,733
                                    $4,583  $5,234
Total Capital Costs
Annual Savings (BIT)
Financial Indicator*
Net Pmsnt Value - Yurc 1-10
Net Pi-went Value - Years 1-15
Internal Rate of Return - Years 1-10
Internal Rate of Return - Years 1-15
            Simple Ptyttck (yftn)
              Paint/Water Separator Project
                         Summary
            • TCA revealed some relevant, significant
             initial and annual costs and savings
             omitted in the conventional company
             analysis
            • The omitted items were:
             • Equipment installation
             • Training
             • Separator sludge waste disposal
             • Waste hauling and hauling insurance
             • Water
             • Sewerage
                                               Slid* 15
£>  1995, Tellus Institute.
                                                                                                  Session 4

-------
        National Technological University - Modern Manufacturing Video Conferencing Series
                     Environmental Cost Accounting and Capital Budgeting
                     July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
           Paint/Water Separator Project
                    Summary


        • Inclusion of the omitted Kerns increased
         annual operating savings of the project by
         approximately 14%
        •This resulted in a moderate increase in
         project profitability
                     Polaroid
                Batch Still Project

               A Total Cost Assessment
                     Case Study
                                        SIM* 17
                                             I

1995, Tellus Institute.
Session 4

-------
           National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12, 1995 -11:1 Sam to 5:00pm Eastern - MC95071201
                      Summary
                        and
                    Conclusions
                                        SIM.1
          Conventional Practices Are Biased
          Against Pollution Prevention and
          Other Environmental Investments

          Total Cost Assessment (TCA)
          Can Level the Playing Field
                                       SIM* 2
          Improved Capital Budgeting
          Practices Can Change
          the Bottom Line

          How Much Depends On Current
          Company Practices and the
          Individual Project
                                      Slid. 3
© 1995, Tellus Institute.
Session 5

-------
        National Technological University - Modern Manufacturing Video Conferencing Series
                      Environmental Cost Accounting and Capital Budgeting
                      July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
        As Illustrated By Case Studies,
        A TCA Approach Will Often
        Improve the Profitability
        Of Pollution Prevention
        Or Other Environmental Projects

        But There Is No Guarantee
                                         Slid. 4
            Costs, As Well As Savings...

        TCA does not ensure profitability for
        pollution prevention or other environmental
        projects.
        in addition to identifying hidden/neglected
        savings generated by environmental
        projects, TCA can also reveal additional
        costs not captured by conventional analysis.
                                         Slk)«S
          The Paper Coating Conversion
                     Project

        i "Business As Usual" was production of
         coated papers, using a solvent-based
         coating mixture and some heavy metal-
         based pigments
        i The alternative project under
         consideration was a switch to aqueous-
         based coating mixtures and heavy metal-
         free pigments
                                         SI Id. 6
1995, Tellus Institute.
Session 5

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         National Technological University - Modern Manufacturing Video Conferencing Series
                        Environmental Cost Accounting and Capital Budgeting
                        July 12,  1995 - 1 l:15am to 5:00pm Eastern - MC95071201
          The Paper Coating Conversion Project
                      Cost Summary
        Capital Costs
                         Company     TCA

                         $893,449  $923,449
                                        $30,000
        Operating
        Savings/(Costs)
         a) Raw Materials       $18,112  ($27,488)
         b) Waste Disposal MgmL $118,000  $308491
         c) Utilities           ($5,000) ($204,776)
         d) Regulatory Compliance  ($5,000)  $11,000
         e) Liability               0  $35,000
                                 $5,080 (tknearoj
         Subtotal
         (without liability)
$126,112  $87,167
 ($45,600)
 $190491  = 1
($199,776)  oi
 $16,000 /r j
 (year13)/!'
 1—Y
 ($38,985)
                                              SIMt7
          The Paper Coating Conversion Project
                    The Bottom Line
         Financial Indicators
         NPV-Years 1-10
         IRR-Year* 1-10

         Simple Payback (yem)
                             Company
                ICA
    ($314,719)   ($480,512)
      6%        0%
       7.6
                                          11.7
                                             SIMll
        TCA Has Wide Applicability Across
           Project/Program Size and Type
                                             Slid. 8
1995, Tellus Institute.
                                                                        Session 5

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       National Technological University - Modern Manufacturing Video Conferencing Series
                  Environmental Cost Accounting and Capital Budgeting
                  July 12, 1995 -1 l:15am to 5:00pm Eastern - MC95071201
       TCA Should Be Customized To a
       Firm's Needs

       No One Approach Is Right for All
                                    Slid* 10
        Improvements Are Likely To Be
          Incremental and Piecemeal
                                    Slktell
               Barriers To TCA
                                    Slid* 12
1995, Tellus Institute.
Session 5

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           National Technological University - Modern Manufacturing Video Conferencing Series
                       Environmental Cost Accounting and Capital Budgeting
                       July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
               Potential Barriers To TCA

           • Start-up costs
           • Managers may not welcome new costs in
            their units
           • Profitability of existing product lines may
            diminish
           • Future disclosure of risk/liability
            information
                                          SIM* 13
            Is the Effort To Implement TCA
                      Worth It?
         The resources necessary to
         implement TCA (i.e., time and
         money) depend on the level of the
         effort, but can have significant
         benefits not only for capital
         budgeting but also for other
         objectives such as product pricing.
                                         Slid. 15
3 1995, Tellus Institute.
Session 5

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       National Technological University - Modem Manufacturing Video Conferencing Series
                   Environmental Cost Accounting and Capital Budgeting
                   July 12, 1995 - 1 l:15am to 5:00pm Eastern - MC95071201
       Once the environmental
       accounting data are available,
       implementation of TCA for capital
       budgeting is clearly worth the
       effort, as illustrated by the case
       studies. TCA provides a clear,
       complete picture of the firm's
       investment options.
                                     Slid* 16
       Although the case for making
       improvements can be made purely
       on the basis of the firm's self-
       interest, improved internal
       environmental accounting may
       also result in multiple social
       benefits.
                                     SIM* 17
1995, Tellus Institute.
Session 5

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GLOSSARY OF FINANCIAL TERMS
     Tellus Institute, Boston, MA

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Annual Cash Flow


Break-Even-Point
Capital Budget
Cash Flow (from
an investment)
Cost Accounting System
Cost Allocation
Discount Rate
Financial Accounting
Financial Reporting
Financial Statements
For an investment, the sum of cash inflows and outflows for a
given year (see cash flow).

The point at which cumulative incremental annual cash flows of
an investment aggregate to 0.  The Break-Even-Point designates
the end of a project's investment Payback Period (see Incremental
Cash Flow and Payback Period).

A statement of the firm's planned investments, generally  based
upon estimates of future sales, costs, production and research and
development (R&D) needs, and availability of capital
The dollars coming to the firm (cash inflow) or paid out by the
firm (cash outflow) resulting from a given investment.

The internal procedure used to track and allocate production costs
and revenues to a product or process.  Defines specific cost/profit
centers,   overhead   vs.  allocated   costs,   degree   of  cost
disaggregation.

A process within an internal cost accounting system of assigning
costs and revenues to cost and  profit  centers for purposes  of
product pricing, cost tracking, and performance evaluation.

The discount  rate (or Cost of Capital)  is the required rate  of
return on  a  capital  investment.   In profitability analysis,  the
discount rate is used in Net Present Value (NPV) calculations to
express the value of a future expenditure in the present year. The
discount rate is expressed as a percentage.

The process that culminates in the preparation of financial reports
relative to the enterprise as  a  whole for use by parties  both
internal and external to the enterprise.

Required  by  authoritative pronouncement, regulatory  rule  or
custom, including: corporate annual reports, prospectuses,  annual
reports  filed  with government  agencies,  descriptions  of  an
enterprise's social or  environmental impact.

The principal  means through which financial  information  is
communicated to those outside an enterprise.  Statements include
the balance  sheet, income statement, and statement of cash
flows.

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 Hurdle Rate
 Incremental Cash Flow
 (of an investment)
                             The internally  defined threshold, or minimum acceptable rate of
                             return,  required for project approval,  e.g. 15% ROI, or 2 year
                             payback.
                            The cash flow of an alternative practice (e.g. after a pollution
                            prevention investment  has  been  implemented)  relative  to the
                            current practice.  Incremental cash flow is calculated  by taking
                            the difference between the cash flow for the current practice and
                            the alternative practice.
 Internal Rate of Return
 (IRR)
Managerial Accounting
                            The discount rate at which the net savings (or NPV) on a project
                            are equal to zero.  The computed  IRR  of an investment  is
                            compared to a company's desired rate of return.

                            The  process  of  identification,  measurement,  accumulation,
                            analysis,   preparation,  interpretation,  and  communication  of
                            financial  information used by management to plan, evaluate, and
                            control all activities within an organization to ensure appropriate
                            use, and accountability for its resources.  Capital budgeting  is one
                            component of managerial accounting.

                            An index that helps to  answer the  question:   are the  future
                            savings/revenues   of a  project  likely  to  justify  a current
                            expenditure?  Synonyms:  "decision rule", or "financial index", or
                            "profitability index", or "capital  budgeting technique".   Includes-
                           NPV, IRR, payback, ROI.

Net Present Value (NPV)  The present value of the future cash flows of an investment less
                           the investment's current cost.
Profitability Indicator
             NPV =
                           CF
                           isi-l
                           1+k
                                                      CF   - I
             where:        CF, is cash flow in period 1
                           CF2 is cash flow in period 2, etc.

                           I is initial outlay or investment cost

                           k is cost of capital or discount rate

                    An investment is profitable' if the NPV of the cash flow it generates in
                    the future  exceeds its cost, that is, if the NPV is positive.

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 Payback Period
Project Financial
Analysis
Project Justification
Process
Project Justification
Return on Investment
(ROI)
Total Cost Assessment
(TCA)
The amount of time required  for an  investment  to generate
enough cash flow to just cover the initial capital outlay for that
investment.

Payback = Investment/Annual Net Income
Costing (i.e. calculating the costs and savings) and calculating
cash flow and/or profitability measures of a project.


A generic term  for a series of steps which are necessary to get
approval for a project.

A document prepared in the project justification process which
comprising a written description of the project, a project financial
analysis, and a  discussion of benefits  and  risks which are not
quantified in the financial analysis.
A measurement of investment performance, calculated as the ratio
of  annual  net income  (minus  depreciation)  over  the initial
investment amount.

ROI = Annual Net Income/Investment
A comprehensive financial analysis of the costs and savings of a
pollution prevention project.  A TCA approach includes:

       a)     internal  allocation  of  environmental  costs  to
             product lines or processes;
       b)     inclusion  in a  project financial analysis of direct
             and indirect costs,  short and long term costs;
             liability  costs,  and  less  tangible benefits of  an
             investment;
       c)     evaluation of project costs and savings over a long
             time horizon, e.g. 10-15 years;
       d)     use of measures of profitability which capture the
             long-term profitability of the project, e.g. NPV and
             IRR.

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                                Modern Manufacturing:
             The National Videoconference  Series for Successful Small Firms

                 Environmental Cost Accounting and Capital Budgeting

                         References for Additional Information
                              Tellus Institute, Boston, MA
 Environmental Accounting

 Gray, Rob. 1993.  Accounting for the Environment. Markus  Weiner Publishing, Inc. New
 York.

 Global Environmental Management Initiative (GEMI).  1994. Finding Cost-Effective Pollution
 Prevention Initiatives:  Incorporating Environmental Costs into Business Decision Making.

 Ditz, Daryl, J. Ranganathan and Darryl Banks, eds.  1995.  Green Ledgers:  Concepts and
 Case Studies of Corporate  Environmental Accounting. World Resources Institute. March 12.


 Principles of Capital Budgeting

 Torborg, Richard H.  1994. "Capital  Budgeting for Environmental Professionals." Pollution
 Prevention Review, pp.  447-464.  Autumn.

 Brealey,  R.A. and S.C.  Myers, Principles  of Corporate Finance, 4th edition, McGraw Hill
 Inc., New York, 1991.

 Garrison, Ray H. and Eric W. Noreen. 1994.  Managerial Accounting, Seventh Edition. Irwin
 Publishers, Boston.

National Association of Accountants. 1990. Statements on Management Accounting, Statement
No. 4A, Practices  and  Techniques:  Cost of Capital.  Prentice Hall Publishers;  Englewood
Cliffs, NJ.
Activity Based Costing

Society Management Accounting.  1993.  Statements on Management Accounting - Practices
and Techniques: Implementing Activity-Based Costing. Institute of Management Accountants;
Montvale, NJ.  September.

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 Cooper, Robin, Robert S. Kaplan, Lawrence Maisel, Eileen Morrissey, and Ronald M. Oehm
 1992.  Implementing  Activity-Based Cost Management:   Moving from Analysis to  Action.
 Montavale, N.J.:  Institute of Management Accountants.

 Cokins, Gary, Alan Stratton and Jack Helbling.  1993.  An ABC Manager's Primer. Institute
 of Management Accountants;  Montvale, NJ.

 Mecimore, Charles D. and A.T. Bell.  1995.   "Are  We Ready for Fourth-Generation  ABC?"
 Management  Accounting,  January.


 Managerial Accounting Surveys

 Price Waterhouse.  1992. Accounting for Environmental  Compliance:  Crossroad of GAAP,
 Engineering,  and Government. Survey #2.

 Price Waterhouse 1994.  Progress on the  Environmental  Challenge:  A Survey of Corporate
 America's Environmental Accounting and Management.  New York.

 White, A.L., D. E. Savage, et al. 1995. Environmental Cost Accounting for Capital Budgeting:
 A National Survey of Management Accountants (Draft).   Prepared for Office of Pollution
 Prevention and Toxics, U.S. EPA. Tellus Institute.  June.


 Financial Analysis Handbooks and Curricula

 Massachusetts Office  of Technical Assistance and Northeast Waste Management Officials'
 Association.  1992.  Costing and Financial Analysis of  Pollution Prevention  Projects:   A
 Training Packet - Workshop Agenda,  Workshop Curriculum,  Case Studies and Report.

 Massachusetts Office of Technical Assistance and Northeast Waste Management Officials'
 Association. 1994. Improving  Your Competitive Position:  Strategic and Financial Assessment
 of Pollution Prevention Projects - Instructor's  Guide.

 Massachusetts Office of Technical Assistance and Northeast Waste Management Officials'
 Association. 1994. Improving  Your Competitive Position:  Strategic and Financial Assessment
 of Pollution Prevention Projects - Training Manual.

 Massachusetts Toxics Use Reduction  Program. 1993.  Curriculum for Toxics Use Reduction
Planners, Fourth Edition. The Toxics Use Reduction Institute, University of Massachusetts
at Lowell.  Spring.

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 United States Environmental Protection Agency.  1989. Pollution Prevention Benefits Manual.
 U.S. EPA, Prepared for Office of Solid Waste and Office of Policy Planning and Evaluation.
 July.

 American Institute  for Pollution Prevention.  1993.  A Primer for  Financial Analysis  of
 Pollution Prevention Projects.  Prepared for: United States Environmental Protection Agency,
 Office of Research and Development. April.

 United States Environmental Protection Agency, Office of Research  and Development and
 Office of Solid Waste.  1992.  Facility Pollution Prevention Guide. May.

 Tellus Institute. 1993.  P2/FINANCE User's Manual.  Tellus Institute.
 Total Cost Assessment Case Studies

 Kennedy, Mitchell L.  1994.  "Getting to the Bottom Line:  How TCA Shows the Real Cost
 of Solvent Substitution."  Pollution Prevention Review, pp.  155-164. Spring.

 White, Allen L., Monica Becker, James Goldstein 199la.  Total Cost Assessment: Accelerating
 Industrial  Pollution  Prevention  Through  Innovative  Project  Financial  Analysis  with
 Applications to the Pulp  and Paper Industry.  Sponsor:   U.S.  Environmental  Protection
 Agency, Office of Policy Planning and Evaluation,  Office of Pollution Prevention.   Tellus
 Institute Study No. 90-020. Revised  Executive Summary, June  1993.

 White, Allen L.,  Monica  Becker,  James  Goldstein  1991b.  Alternative Approaches to the
 Financial Evaluation of Industrial Pollution Prevention Investments.  Prepared for: New Jersey
 Department of  Environmental  Protection,  Division  of Science and Research, Project No.
 P32250. Tellus Institute Study No. 89-206.  Revised Executive  Summary, June 1993.

 White, Allen L., M. Becker and D.E. Savage.  1993b.  "Environmentally  Smart Accounting:
 Using Total Cost Assessment To Advance Pollution Prevention," Pollution Prevention Review.
 Tellus Institute, Boston. Summer.
Savage.  Deborah  E. and  Allen  L. White.   1994-95.
Assessment," Pollution Prevention  Review.  Winter.
"New Applications of Total Cost
White, A.L., D.E. Savage and A. Dierks.  1995.  "Environmental Accounting:  Principles for
the Sustainable Enterprise," TAPPIInternational Environmental Conference, Atlanta, GA. May
7-10.

Wittman. Marlene R. 1991.  "Wrayburn Jewelry Company,  Inc., Sutton Facility:  Costing and
Financial  Analysis of Pollution  Prevention  Projects."   Massachusetts  Office  of Technical
Assistance  and Northeast Waste Management Officials' Association.  July.

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 Wittman, Marlene R.  1991.  "Lightolier,  Inc., Fall River Division:   Costing and Financial
 Analysis of Pollution Prevention Projects."  Massachusetts Office of Technical Assistance and
 Northeast Waste Management Officials' Association.  July.

 Disclosure  of Environmental Liability

 Edwards, Paul N.   1992.   "A Comparison of FASB and SEC Accounting  and Disclosure
 Requirements for Environmental Contingencies," Understanding Environmental Accounting and
 Disclosure  Today.  Executive  Enterprises, Inc. New York.

 Also see Price-Waterhouse surveys.
 EPA DIE Resources

 U.S.  Environmental  Protection  Agency.  1993.   Design  for the  Environment:  EPA's
 Environmental Network for Managerial Accounting and Capital Budgeting.  Document No.
 EPA  742-K-93-002; Prevention, Pesticides, and Toxic Substances. October.

 U.S. Environmental Protection  Agency. 1994.  Environmental Accounting Resource Listing.
 Document No. 742-F-94-004; Office of Pollution Prevention  and Toxics. July.


 Pollution Prevention Financing Sources

 U.S. Environmental Protection Agency. 1995. Financing Pollution Prevention Investments:  A
 Guide for Small and Medium-Sized Businesses.  Boston.  (Focuses on sources of financing  in
the Northeast states).

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                                                                     Tellus Institute - Boston, MA

                 INVENTORY OF POTENTIAL COSTS/SAVINGS
 INITIAL COSTS
                            *'
 Purchased Equipment
        Equipment -   e.g. process, monitoring, preparedness/protective,  safety, storage & materials
                      handling, laboratory/analytical
        Delivery
        Sales Tax
        Insurance
        Price for  Initial Spare Parts

 Materials
        Piping
        Electrical
        Instruments
        Structural
        Insulation
        Other Materials - e.g. painting, ducting

 Utility Systems and Connections
        General Plumbing
        Electricity
        Steam
        Water - e.g. cooling, process
        Fuel - e.g. gas, oil
        Plant Air
        Inert Gas
        Refrigeration
        Sewerage

Site Preparation (Labor, Supervision, Materials)
        In-house
        Contractor/Vendor/Consultant  Fees
        Demolition & Clearing
        Old Equipment/Rubbish  Disposal
        Grading, Landscaping
        Equipment Rental

Construction/Installation  (Labor, Supervision, Materials)
        In-house
        Contractor/Vendor/Consultant  Fees
        Equipment Rental

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                                                                      Tellus Institute - Boston, MA
Planning/Engineering (Labor, Supervision,  Materials)
        In-house Planning/Engineering, e.g. design, drafting, accounting
        Contractor/Vendor/Consultant Fees
        Procurement

Start-up/Training (Labor, Supervision, Materials)
        In-house
        Contractor/Vendor/Consultant Fees
        Trials/Manufacturing Variances
        Training

Permitting (Labor, Supervision, Materials)
        In-house
        Contractor/Vendor/Consultant Fees
        Permit Fees

Working Capital
        Raw Materials
        Other  Materials & Supplies
        Product Inventory

Contingency

(Salvage Value)
OPERATING COSTS

Direct Materials
       Raw Materials - e.g. wasted raw materials costs/savings
       Solvents
       Catalysts
       Transport
       Storage

Direct Labor
       Operating - e.g. worker productivity changes
       Supervision
       Manufacturing Clerical
       Inspection/QA/QC  •


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                                                                        Tellus Institute - Boston, MA
  Utilities
         Electricity
         Steam
         Water - e.g. cooling, process
         Fuel - e.g. gas, oil
         Plant Air
         Inert Gas
         Refrigeration
         Sewerage

 Waste Management (Labor, Supervision, Materials)
         Pre-treatment
         On-site Handling
         Storage
         Treatment
         Hauling
         Insurance
         Disposal

 Regulatory Compliance (Labor, Supervision, Materials)
         Permitting
         Training - e.g. Right-To-Know training
         Monitoring/Inspections
         Testing
        Labeling
        Manifesting
        Recordkeeping
        Reporting
        Generator Fees/Taxes
        Closure/Postclosure Care
        Value of Marketable Pollution Permits, e.g. SOx
        Avoided Future Regulation, e.g. CAA amendments

Insurance

Future Liability
        Fines/Penalties
        Cost of Legal Proceedings, e.g. transaction costs
        Personal Injury
        Property Damage
        Natural  Resource Damage
        Superfund

Revenues
        Sale of Product - e.g.  from changes in manuf. throughput, market share, corporate image
        Marketable By-Products

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     TCA AT WORK:  A CASE STUDY IN THE PULP AND PAPER INDUSTRY
                                   Paper Coating Mill
                             White Water/Fiber  Reuse Project
The following case study illustrates the difference between a company's financial analysis of
a pollution prevention project and a Total Cost Assessment (TCA) of the same project.  The
"Company Analysis" is the financial analysis performed  independently by the  company to
evaluate the profitability of a pollution prevention project.  In contrast, the "TCA" is a more
comprehensive  financial analysis of the same project,  developed  collaboratively  by  the
company and Tellus, to illustrate  the differences in profitability when a more comprehensive
approach is used. This case study describes the project under consideration and assesses both
qualitatively and quantitatively the differences in the Company Analysis vs. the TCA.
                              Tellus Institute, Boston, MA

                               From work sponsored by:
                   New Jersey Department of Environmental Protection
                           Division of Science and Research

                                  Revised June 1993

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                             COATED FINE PAPER MILL
 Company Background

 A specialty paper mill is part of a larger corporation of pulp, paper, and coating mills.  The
 mill is not integrated, i.e. does not manufacture pulp.  Most of the pulp used by the mill is
 purchased via pipeline from a neighboring bleached kraft mill.  The mill  supplements this
 pulp with a small amount of purchased market pulp. The mill produces approximately  190
 tons per year of a variety of uncoated, on-machine and off-machine coated papers,
 carbonizing,  book, and release base paper.  The coating used is a latex (i.e. non-solvent)
 formulation containing  clay, styrene butadiene, starch, and polymers.
Project Background

Papermachine white water, a mixture of water and residual fiber and filler (clay and
calcium carbonate) that drains  out of a sheet of paper as it travels across the paper machine,
is typically captured by a white water collection system dedicated to one papermachine.
Some or all white water is usually  recycled back into the papermaking system to recapture
water, fiber and filler. In  some cases white water is passed through a saveall screening
device to separate fiber and filler from water; fiber, filler and water are then recycled back
into the system.  The saveall produces a clear stream of water that can be used in numerous
papermachine operations.

In this mill, two paper machines, sharing a common white water system, produce a variety
of paper grades made with either acid, neutral, or alkaline sizing chemistry.'   Machine 1
has a saveall system that filters fiber and filler prior to discharging into the joint white
water system.  This material is recycled back into the papermaking system.  When the
machines  are using different sizing chemistry, e.g. when Machine 1 is producing acid-sized
paper and Machine 2 is producing alkaline-sized paper, the mixed white water from both
machines  is not reusable, and must be sewered. Under these conditions, a large flow of
potentially reusable water from both machines, and fiber and filler from Machine 2, is lost
to the sewer.

Prompted primarily by the lack of spare water effluent pumping capacity and a desire to
better understand the rather complex, old white water piping system, the mill commissioned
a study titled "White Water Recycle Feasibility  Study." The study had several objectives:
    1   Sizing is added to pulp to reduce water absorbency in the final paper.  The pH (i.e.
acidity or alkalinity) of the pulp must be adjusted according to the type of paper desired and
sizing used.

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 "...to  review the design and operation of the mill and recommend changes that would help
 reduce peak effluent flows,  reduce BOD in the effluent and reduce total fresh water intake
 on a mill wide  scale".  The  resulting report contained detailed engineering drawings of the
 fresh water, white water, and paper machine systems and a recommendation for process
 modifications.
 Project Description

 The recommendation made in the feasibility study was the installation of a second saveall
 to handle the Whitewater from Machine 2, and the splitting of the Whitewater systems so
 that each machine  would have a dedicated system.  This would permit fiber, filler and water
 reuse on both machines at all times, thereby conserving raw materials and reducing  water
 consumption, wastewater generation, and energy use for fresh and wastewater pumping and
 freshwater heating.  The project would require installation of a new saveall, a new pump,
 piping, and controls. Available pulping and stock storage capacity could  be used  to pulp
 separately  for each machine.
Project Financial Analysis

The feasibility study also contained a capital estimate for the project of $1,469,404.  The
estimate includes:  purchased equipment (including saveall, stock chest, clear white water
chest and associated equipment); process control instrumentation; electrical controls and
lighting; a new building for the saveall; piping; installation (in-house and contracted labor);
engineering;  and contingency.
Company and TCA Analyses

The Company Analysis consists of the capital estimate,  and only those operating costs and
savings that the company typically includes in project financial analyses  for projects of this
type. These are:

       a.      raw material - fiber and filler;
       b.      energy and chemical use for new equipment;
       c.      wastewater treatment fees; and
       d.      changes in labor costs.

The TCA contains these and other relevant operating costs and savings.  On the benefit
side, the TCA includes the following:
       a.
An average reduction in fiber and filler loss of 1,200 tons/year, for a savings
of $421,530/year;

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        b.     A reduction in fresh water usage of 1 million gal/day, and a commensurate
              reduction in cost for fresh water treatment and pumping, for a savings of
              approximately  $112,420/year;
        c.     A reduction in energy use for fresh water heating amounting to a savings of
              approximately  $393,400;  and
        d.     A reduction in wastewater generation of approximately  1 million  gal/day, for
              a savings of approximately $54,750/year in wastewater pumping and
              $68,240/year in wastewater treatment fees.

 Annual operating costs are expected to increase in the following areas:

        a.     Chemical flocculating  agents used in the saveall  to promote solids/water
              separation will cost approximately $28,700/year;
        b.     Electric costs for new equipment operation will increase operating costs by
              approximately  $107,280/year; and
        c.     An increase in labor cost of approximately $3,120/year is expected for
              operation of new equipment.

 The project does not affect wastestreams that require on-site management or disposal, nor
 does it affect any regulatory compliance activities at the site; therefore the financial  analysis
 does not include costs for these activities.  In addition, no impacts on revenue are expected
 since neither product quality nor production rates will be improved, nor does the mill
 expect to visibly enhance its product or company image.  Finally, no tangible impact on
 avoided future liability is expected for this project.

 Table  1 summarizes the cost  categories  addressed in the Company Analysis and the TCA
 for this project, and Table 2 reports the results of the financial  analysis.


 Effect of Cost Inclusion on Financial Indicators

As shown in Table 2, the inclusion hi the TCA Analysis  of savings associated with
freshwater pumping, treatment, and  heating, and waste water pumping  dramatically
increases the annual savings  and financial indicators above the  Company Analysis base
case. These savings, which would typically not be  included in  the mill's calculation  of
profitability, bring the project in line with the mill's 2 year payback rule-of-thumb.  By
excluding these savings in the Company Analysis, the project looks reasonably "profitable"
only over the longer time horizon of 15 years.

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  Table 1  Comparison of Cost Items in Company and TCA Cost Analyses
  X = Cost(s)  Included
  P = Cost(s)  Partially Included                    Company
 Capital Costs
         Purchased Equipment
         Materials (e.g., Piping, Elec.)
         Utility Systems
         Site Preparation
         Installation (labor)
         Engineering/Contractor
         Contingency
 X
 X
 X
 X
 X
 X
 X
                         TCA
X
X
X
X
X
X
X
 Operating Costs
         Direct Costs:*
                 Raw Materials/Supplies
                 Labor
         Indirect Costs:*
                 Utilities:
                         Energy
                         Water
                         Sewerage (POTW)
 P
 X
P

X
X
X
X
X
X
 * We use the term "direct costs" to mean costs that are typically allocated to a product or process line (i.e. not
 charged to an overhead account) and are typically included in project financial analysis. "Indirect costs" here mean
 costs that are typically charged to an overhead account and typically not included in project financial analysis.
Table 2  Summary of Financial Data for the White Water and Fiber Reuse Project
Total Capital Costs

Annual Savings (BIT)*

Financial Indicators
Net Present Value -  Years  1-5
Net Present Value -  Years  1-10
Net Present Value -  Years  1-15
internal Rate of Return - Years 1-5
Internal Rate of Return - Years 1-10
Internal Rate of Return - Years'* 1-15
Simple Payback (years)
Company Analysis

 $1,469,404

 $ 350,670
($ 476,408)
S  47,240
$  359,544
    1%
   17%
   21%
   4.2
       TCA

       $1,469,404

       $  911,240
       $  783,232
       $2,072,306
       $2,849,725
          37%
          46%
          48%
          1.6
* Annual operating cash flow before interest and taxes
Some uncertainty exists in the wastewater  treatment  cost estimate.  Because the mill does
not have its own wastewater  treatment  facility, wastewater from the mill is pumped  to a
neighboring mill for treatment.  In the  per ton flow,  Total Suspended  Solids (TSS) and
                                                   4

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 Biological Oxygen Demand  (BOD) for the subject mill is reportedly higher than the
 industry average.  The neighboring mill has asked the subject mill to reduce wastewater
 flow, although no such measures have been put into effect to date.  The treatment  charge is
 not based on TSS or BOD so the subject mill has no direct economic incentive to  reduce
 TSS and BOD in  its wastewater.  The contract between the mills establishes a ceiling for
 wastewater  flow, BOD and TSS from the mill.  Currently, the subject mill is meeting its
 flow limit, but is substantially exceeding its contract limits on BOD and TSS.

 The treatment contract will be renegotiated in 1993, but it is not clear whether, or  how, the
 terms will be changed. However, the mill's environmental, engineer  speculated that the
 charge rate  formula might be changed to include a BOD or TSS variable, and  that the
 overall cost could increase.  To test the  sensitivity  of the  project analysis to these potential
 changes, the TCA was recalculated twice,  doubling and tripling the wastewater treatment
 costs.  In both  cases, the financial indicators change slightly:  50% IRR (years 1-10) and
 1.5 payback for double the cost, and 53%  (years 1-10) IRR and 1.4 payback for triple the
 treatment cost.   While there is no dramatic  change in projected profitability, a  tripling of
 wastewater  treatment costs, may make this  project  somewhat more competitive with other
projects competing for capital in a particular budget year.  This may be especially true  if
the firm applies its rule-of-thumb, 2 year payback criteria as a screening test for the project.

Detailed  reports of the Company Analysis,  the TCA, and  associated cost calculation
documentation  follow.

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                                 White Water/Fiber Reuse Project
                         Costing and Financial  Analysis Documentation
 A.  Capital Costs

 Purchased Equipment:    $345,985
         Saveall and White  Water Pump

 Materials:               $374,822
         Piping, Electrical, Instruments and Structural
 Installation:

 Engineering:

 Contingency:
$397,148

$211,046

$140,403
B.  Operating Costs

Key:    M - thousand
        MM - million
        GD  - gallons/day

                  Current Process

1. RAW MATERIALS

l.a.  Fiber and Filler Loss (includes freight)

Estimated solids loss  = 1,500 tons/yr
White water solids =  67% fiber, 33% filler

Fiber  loss:
1,500 tons/yr * 0.67 = 1005 tons/yr
Fiber  cost = $445/ton
Lost fiber cost = 1005 tons/yr * $445/ton =
        $447,220/year

Filler loss:
1,500 tons/yr * 0.33 = 495 tons/yr
Filler cost = $161/ton
Lost filler cost = 495  tons/yr * S161/ton =
        S79,700/year
                                        White Water and Fiber Reuse
                              l.b.  Fiber and Filler Loss (includes  freight)

                              Estimated recoverable  solids = 1,200 tons/year
                              Estimated solids loss = 1,500 - 1,200 = 300 tons/yr

                              Fiber loss:
                              300 tons/yr * 0.67 = 201 tons/yr
                              Fiber cost = $445/ton
                              Lost fiber cost = 201 tons/yr *  5445/ton =
                                     $89,450/year

                              Filler loss:
                              300 tons/yr * 0.33 = 99 tons/yr
                              Filler cost = $161/ton
                              Lost filler cost = 99 tons/yr * $161/ton =
                                     $15,940/year

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                 Current Process

 1.  RAW MATERIALS  (cont.)

 I.e. Freshwater Treatment

 Annualized freshwater use = 1.5MMGD

 Chemical Costs:
                        S/MG
 Alum                   0.025
 Sodium aluminate        0.009
 Polymer                0.034
 Sodium hypochlorite     0.003
                Total   S0.071

 1.5 MMGD * 365 days/yr *($0.071*1000)/MMG =
        S38,870/year
           White Water and Fiber Reuse



l.d. Freshwater Treatment

0.5MMGD  freshwater	> = $12,960
                                                    I.e. Flocculating Agents for Saveall

                                                    Avg. white water flow through saveall = 600 GPM
                                                    (864 MGD)

                                                    Chemical  Costs:
                                                    Cationic polymer cost = $0.056/Mgal
                                                    Anionic polymer cost = S0.035/Mgal
                                                                     total $0.091/Mgal

                                                    864MGD  * S0.091/Mgal * 365 days/yr =
                                                           S28,700/year
2. UTILITIES

2.a.  Freshwater Pumping

Annualized freshwater use = 1.5MMGD

Energy Costs:
                               S/period'  S/MG
Variable freshwater pumping     133,098    0.234
Miscellaneous                    1.479   0.0026
                       Total  $134,577   $0.237

'period - 8 months,  1990
total freshwater use - 566,460 MG

1.5MMGD * 365 days/yr *  ($0.237* 1000)/MMG  =
       $129,760/year
2.b.  Freshwater Pumping

0.5MMGD freshwater	> = $43,250/year

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                  Current Process

 2.UTILITIES (cont.)

 2.c.  Freshwater Heating

 1.5MMGD freshwater comes  in at 57°F, must be
 raised to 95°F

 1.5MMGD * I Btu/lb°F * 8.4 Ib/gal * (95 - 57°F) =
 4.788 x 10s Btu/day

 Fuel cost (No. 6) = $0.39/gal
 Estimated boiler efficiency = 82.5%

 4.788 x 108 Btu/day * 1 gal No. 6 fuel/1.4 x 105 Btu
 * S0.39/gal * 1/0.825 * 365 days/yr = S590,100/yr
           White Water and Fiber Reuse



2.d. Freshwater  Heating

0.5MMGD freshwater	> = S196,700/yr
2.e.  Wastewater Pumping

4.0MMGD * 365 days/yr * S150/MMGD
        $219,000/yr
2.f. Wastewater Pumping

3.0MMGD 	> = $164,250/yr
2.g.  Wastewater Treatment

Average, annualized wastewater discharge rate =
4.0MMGD
Wastewater treatment cost = S187/MMG

4.0MMGD *  365 days/yr *  S187/MMG =
        S273,020/yr
2.h. Wastewater Treatment

3.0MMGD	> = S204,760/yr
                                                    2.i. Energy for Equipment Operation

                                                    Electricity cost = $0.08/kWh

                                                    New Equipment                 HP
                                                    Drive Pump                             1
                                                    Scoop Pump                             1
                                                    Pressure Pump                          40
                                                    Feed Pump                             20
                                                    Recovered Stock  Chest Agitator Motor      5
                                                    Recovered Stock  Chest Pump             25
                                                    Clear White Water Chest Pump          125
                                                    White Water Surge Pump                125
                                                                                  Total    342 HP
                                                    342 HP * 0.6 * 0.746 kWh/HP  * 8.760 hr/yr
                                                    S0.08/kWh = $107,280

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                 Current Process
3. LABOR
White Water and Fiber Reuse
                                                     3.a. Equipment Operation - Saveall

                                                     4 hours/week labor
                                                     $15/hour - fully loaded wage rate

                                                     4 hrs/week * 52 weeks/yr * S15/hr = S3,120/yr

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     REVISED EXECUTIVE  SUMMARY


                     JUNE 1993


ALTERNATIVE APPROACHES TO THE FINANCIAL

    EVALUATION  OF INDUSTRIAL POLLUTION

           PREVENTION INVESTMENTS
                     Prepared for:

      New Jersey Department of Environmental Protection
             Division of Science and Research
                   Project No. P32250
                         By:

                  Allen L. White, Ph.D.
                 Deborah Savage, Ph.D.
                    Monica Becker
                  Risk Analysis Group
                    Tellus Institute
                  11 Arlington Street
                 Boston, MA 02116-3411
                   Tel: 617-266-5400
                   Fax: 617-266-8303

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  PREFACE

        This Executive Summary supercedes a version originally published in a November 1991
  report to the  New Jersey Department of Environmental  Protection entitled: Alternative
  Approaches to the Financial Evaluation of Industrial Pollution Prevention Investments.
  This revised version includes changes to the text for purposes  of clarification and completeness,
  as well as new results of the financial analysis of three pollution prevention projects. The latter
  changes reflect both refinements to the analytical tool used  in the original profitability analysis
  and the availability of new data on the costs and savings of the projects themselves.

        Taken together,  the three revised analyses reinforce the central finding  of the original
  study ~ that improved  managerial accounting  systems, including accurate measurement and
  allocation of both physical and  cost aspects of waste generation, are essential for achieving a
  clear, unbiased perspective on the profitability  of industrial pollution prevention investments.


 BACKGROUND

        Both  regulatory and  market forces are  moving  firms  to  re-think their pollution
 management practices.  Regulatory pressures in the  form of pollution disclosure  requirements,
 bans on land  disposal of many hazardous  wastes, escalating waste  disposal costs,  bans or
 limitations on the use of certain hazardous  materials and other federal and state mandates act
 as strong inducements to prevent rather than control pollution. Reinforcing these pressures are
 market incentives, some created by government  ~ e.g., tradable permits and taxes on hazardous
 waste  -  and  others by public  and consumer demand for  clean technologies and  "green"
 products.  When  these regulatory  and market forces are taken together, the  prevention path
 should  look increasingly attractive to companies from the standpoint of both  compliance and
 market competitiveness.

       Despite  these trends, however, the pace of conversion to a more preventive mode of
 environmental  management has been slow, and many seemingly profitable pollution prevention
 opportunities  remain unexploited.   If such investments  are in  the best interests of a profit-
 driven firm, why  does such underinvestment in prevention persist?  The  answer is arguably
 two-fold:  (1) organizational:  characteristics of the  firm in  the form of weak signals from top
 management,   failure  to assign environmental  managers  adequate  authority  over  capital
 investments, and insufficient information flow to product design and operations  staff to build
 a broad constituency  for  prevention  projects;  and (2)  financial: the inability of pollution
 prevention investments to compete  with other potential uses  of limited capital because they are
 disadvantaged  by  standard project evaluation techniques,  and/or external and internal barriers
 in the form of inaccessibility to  capital for  prevention investments.

       Internal economic barriers, the focus of this study, are  best assessed within the  context
of a firm's capital budgeting process.  Prevention  projects compete  with other demands for
scarce  capital  resources.  Decisions on such projects and other  candidate  investments reflect

                                            1

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 a combination of financial analysis, qualitative assessments, and management instinct. Because
 some economic returns to prevention projects tend to materialize  in diverse and indirect forms,
 and occur over a longer time horizon, conventional project analyses may underestimate or omit
 altogether their returns to the firm.   Such is the case, for example,  when  avoided liability,
 reduced staff time for compliance, and enlarged market share owing to a "green" product image
 are not incorporated into a project analysis.   The result is that prevention projects as a group
 may confront systematic  bias in capital  allocation  decisions, resulting in  potential chronic
 underinvestment in such projects.

        Total  cost  assessment  (TCA) offers  an  alternative to conventional project analysis
 approaches by extending the cost/savings inventory and time horizon, improving cost allocation
 procedures, and using long-term profitability indicators.  The effect of a TCA approach should
 be to  "level  the playing field", such that prevention investments  receive a balanced appraisal
 by managers  responsible  for allocating capital resources.

        For this study, ten firms of varying size and product lines were  interviewed in Phase
 I to determine the potential roles of, and receptivity to, TCA approaches  in industry. In Phase
 II three of these  firms - a paper coating  mill, a diversified chemical firm, and  a  metal
 fabrication and finishing firm - cooperated in preparing in-depth project analyses using a TCA
 approach.   This approach builds upon earlier TCA methods while attempting to overcome a
 number of weaknesses which have thus far hindered their adoption:  unfamiliar and inflexible
 costing format, lack  of user-friendly software,  and  incompatibility with  current company
 practices.

        In the context of the capital  budgeting process, how do companies conduct project
 financial analyses?  How do these  practices compare to a TCA approach?  What  effect does
 TCA have on the estimated profitability of a pollution prevention investment?  To answer these
 questions we compare three aspects of current project analysis practices employed by the three
 Phase  II companies with comparable  parameters  of TCA analyses:  financial indices, time
 horizons and  cost coverage.  This is accomplished through the comparison of a  "Company
 Analysis" with a TCA for each of the three pending investments.

       A brief description of the procedures used to develop the "Company Analyses" and the
 TCA Analyses is in order.  The development of project financial analyses was structured to
 allow comparison between a TCA approach and that which had been previously used by the
 three Phase II firms.  Two  steps were necessary.  First, we needed  to develop  a baseline
 financial analysis for each project, which we term the "Company Analysis".  Each Company
 Analysis consists of only those costs which had been included in the firm's evaluation of eithe'r
the  complete project or components of the project thus far analyzed by the firm.

       Since  the prior financial analyses undertaken by the firms appear in  numerous forms
and. in two instances,  appear in several documents,  we  converted disparate  information into
a uniform format to compare with a TCA analysis.  To do this, we used a spreadsheet system
developed by Tellus to collect and organize capital and operating cost  data, to calculate cash

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 flow data and financial indices, and to perform sensitivity analysis to test the effect on financial
 indices of various costing approaches.
 COST INVENTORY

        The comparison  of the Company Analyses and the TCA Analyses solely on the basis
 of cost inventory is relatively straightforward.  We simply compare the capital, cash flow,  and
 financial indicators derived  from the Company Analysis with those derived from the TCA
 (Appendix B).  This single  dimension comparison shows the impact of an  expanded list of
 costs and savings on the financial indicators for the project.

        While cost categories in a financial analysis tend to differ according to the nature of the
 project, we  can infer from the Phase  II Company Analyses  the types  of costs  typically
 considered  in project analysis.  Table  ES-1  presents  the costs  included  in  the  Company
 Analyses and the TCA  Analyses.'  The TCA column represents  a complete  picture of the
 internal costs and  revenues  affected by the project.  By comparing the Company Analysis
 column with the TCA column, a picture of the firm's project costing approach emerges.

        Direct and Indirect  Costs.  In the case of Project 1  (Table ES-1), the Paper Coating
 firm omitted all non-disposal waste management costs, utilities (energy, water and sewerage),
 solvent recovery, and regulatory compliance costs from its analyses  of the aqueous conversion
 project.  The firm also omitted several costs associated with the storage needs and shorter shelf
 life of aqueous coatings; namely a steam heating system for the coating storage  shed, lost raw
 material value, and cost  to dispose of spoiled coating.

       The Metal Fabrication Company (Project 2) did not include installation and training in
 its capital  estimate  for  the  paint/water  separator,  and omitted waste  hauling and hauling
 insurance, water, and sewerage costs from the annual  operating cost estimate. While the firm
 considered the avoided  cost of disposing of the paint/water and oil/water waste, it did  not
 include the cost to  dispose of the sludge generated by the separator.

       The financial analyses developed by the company for Project 3 were extremely detailed
 and comprehensive.  Since the waste stream  targeted  for recovery  is not a RCRA waste, it is
 not subject to manifesting, monitoring, reporting and other regulatory requirements. Therefore,
 we can  not  infer from  the  Company Analysis  whether regulatory  or non-disposal  waste
 management  costs are normally considered by this firm.
    1  In the case of Project 2, labor costs were explicitly considered by the firm but were not
quantified because they would not be affected by the project.  Therefore, we have checked off
labor  costs in both the Company and TCA columns.

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         Future Liability Costs.   We  focus on two  general  forms of future  liability costs-
  liability from  personal injury or property damage (e.g., Superfund liability stemming from a
  leaking landfill), and penalties and fines for violation of environmental regulations.   None of
  the companies for  which in-depth project  studies were completed included an estimate of
  avoided future liability costs in their financial  analyses.  In the case of Project  1  the Paper
  Coating firm  indirectly  alluded to this benefit  in a qualitative  way in  its Appropriations
  Request: "...major reductions in levels of fugitive emissions,  and amounts  of solid hazardous
  waste going to landfill, is very positive from a regulatory and community  standpoint".

         The Metal Fabrication Company did not  include an  estimate or  mention  of future
  habi hty in  its  analysis  of Project 2. By complying with state and federal hazardous waste
  regulations  and sending all waste to an incinerator,  the Company believes it  is safe from future
  financial liabilities from fines, personal  injury and property damage. In a previous project  the
  firm analyzed the direct economic benefits of a new paint procurement policy in light of a sta'e
  regulation which contained a set of fines for improper shipping of hazardous materials  Since
  the Company was not meeting these requirements,  the staff engineer clearly noted a potential
  fine of up to $25,000 after two offenses.  If incurred, the fine would far outweigh  the long-
 term  savings  in operating costs for the new  system.   The  decision to  suspend  the new
 procurement practice was based in  large measure  on the threat of fines.

       . During the Phase I interview with the Diversified Chemical  Company, we learned that
 Company financial analysts are cautious in valuing indirect and intangible benefits of a project
 -Instead, they choose to calculate  only  conventional,  direct costs while leaving TCA-type
 benefits such as avoided liability as qualitative inputs in appropriation requests.  Although the
 Company has developed a procedure for estimating costs associated with Superfund liability
 d included neither an estimate nor mention of avoided future liability in any  financial analyses
 tot Project 3.

       While none of the Phase I or Phase II firms include estimates of avoided future liability
 in their  quantitative project analyses, it is important to emphasize that our cases demonstrate
 that liabihry  avoidance is a major concern of companies.  Many of the companies interviewed
 are looking  to  pollution prevention to  minimize the likelihood  of liability associated  with
 hazardous waste generation. However, the availability of incineration as a disposal option to
 some extent provides firms with a level of comfort which may act as a disincentive to pollution
 prevention.

       Less Tangibk Benefits. Less tangible benefits from pollution prevention investments
 such as  increased revenue from enhanced product quality, improved Company or product
 image, increased worker  productivity, and reduced worker health maintenance costs are among
the most difficult to  predict and quantify.  None of the  three Company Analyses  or TCA
Analyses contain estimates o^ less tangible benefits. In the case of Project  1, the coated paper
product  is sold  domestically,  on the basis  of cost,  visual appearance,  and  performance
durability to  book publishers  aii-4 other intermediate product  manufacturers.   Although the
Company expects some quality improvements using aqueous  coating, it does not  anticipate an.
                                           4,

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  increase in market value.  Therefore, it expects no increase in domestic sales as a result of the
  conversion to the aqueous/heavy metal-free coating. However, the Company hopes to improve
  its competitive  advantage in the European market if the European Economic  Community
  implements  an anticipated  lead-free  packaging  standard which would apply to books.
  However, it  would not speculate  on the potential revenue effects associated  with increased
  European market share.

        Neither the Metal Fabrication Company nor the Diversified Chemical Company expects
 to increase market share or product value as a result of Projects 2 and 3, respectively.  Both
 of these companies, as well as the Paper Coating firm, are manufacturers of intermediate, not
 consumer,  products.  As  such,  they cannot directly  market their products on the  basis of
 environmental attributes in the same way that a consumer products manufacturer can.

        A reduction in solvent use at the Paper Coating  firm will certainly reduce  worker
 exposure to fugitive solvent emission, and the  elimination  of nitrocellulose from the coating
 mixture will  reduce flammability and explosivity  hazards.  While reduced solvent exposure
 may result in a lower incidence  of worker illness  over the long-term, and the elimination of
 nitrocellulose may result in fewer worker injuries, we lacked adequate data to estimate the
 potential  impact of these  benefits on either the Company's  health care costs or long-term
 worker productivity.  In this case, this issue was  dealt with qualitatively in a section of an
 Appropriations Request called "Safety/Health Impact of Converting from Solvent to Aqueous
 Coating".

       Although many Company representatives noted that project benefits are more persuasive
 if they are monetized and included in the project financial analysis,  when costs are difficult or
 impossible to monetize a qualitative approach may be more credible to management.

       Discovery of previously  omitted non-environmental costs.  In developing the TCA
 Analyses, we  added to the  Company Analyses any  capital or operating costs or savings which
 could  be attributed to  the project  and reasonably estimated.   While  our focus  was on
 environmental costs typically omitted from project analyses, the process of developing a more
 comprehensive  list  of costs unearthed, in the case of  Projects 1  and 2,  other, "non-
 environmental" costs not originally included by the Company.  For example, in Project 1, all
 previous analyses of the aqueous/heavy-metal free conversion ("aqueous coating conversion")
 omitted the costs of heating system  installation, the energy needed  to prevent  the aqueous
 coating from  freezing, and the additional energy needed to  dry aqueous versus solvent-based
 coating. While the latter cost was acknowledged by several production engineers and managers
 in1 meetings with Tellus, it had never been estimated nor included in previous analyses. In the
 case of Project 2, equipment installation and operator training costs (while admittedly small)
were not included in the Company's initial analysis. These items, which tended to increase the
cost of the prevention  project, were included in the TCA Analysis.  Thus, the TCA Analyses
of Projects  1  and 2 illustrate that non-environmental. direct and indirect costs may  also be
omitted project analyses.'

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  FINANCIAL INDICES

         Financial  indicators  are  used as a critical,  though not exclusive, decision marker  in
  analyzing pollution  prevention  projects.   Firms typically use such indicators as auidenosts
  rather than decisive  elements in judging the merits of a proposed project.  Their application
  tends to  be flexible, that is, subject to substantial management discretion as proposals move
  through the formal or informal  budgeting process  and  compete  with  one another for scarce
  capital.

        The choice of financial indicators to assess project performance ranges from the simple
  single-indicator evaluative process  used by most small  firms to a two or more-stage process
  among larger size firms which often use several indices,  For the former,  simple payback is
  dominant. For the latter, payback (or slightly more sophisticated ROI) is typically used as  a
  first screen.  If a project passes a prescribed hurdle  rate, a more in-depth analysis using NPV
  and/or IRR is common.                       -                                         .

        In our study, the Auto Radiator Shop and the Electroplating  Company, both small firms
 use a simple payback calculation to evaluate projects.  If a project meets or exceeds a hurdle
 rate  of  1-2  years and  1 year,  respectively, the  project  is  considered  profitable    The
 Refrigeration Company,  a medium-sized firm, looks favorably upon projects with a 2-3 year
 payback.  In none  of these cases is the hurdle rate  inflexibly applied.  Instead, the project's
 place in  the  strategic thinking of top management and external  pressures  from customers
 regulators, and the community help  define how rigidly the hurdle rate will be used in judging
 a project's desirability.                                                           J   & &

        The Paper Coating Company  and the Diversified Chemical Company,  both large firms
 use an ROI to sc:een proposed projects before subjecting them to more in-depth NPV and IRR
 analyses.   Tfo.s  practice provides  the project proponent with an informal estimate of expected
.performance prior to investment  of staff resources  (and personal  capital)  in advocating  an
 investment.  Once  the ROI milestone is passed, the proposal typically moves into a divisional
 or sectoral review where more sophisticated calculations are developed  to capture longer-term
costs/savings.
TIME HORIZON

       Time horizon, of course, is closely tied to financial indicators. By nature, payback and
ROI calculations are not capable of capturing long-term costs/savings,  a serious shortcoming
in the case of liability estimation where costs (and cost avoidance)  may  materialize  10 years
or more into a project's lifecycle.  NPV and IRR, on the other hand, both account for future
years costs/savings.  Their use is common in large firms and large investments whose market
and budgeting  horizons, are extended and who are financially capable of waiting many years
for an investment'to break-even and begin tuning a  positive cash flow.

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        Though the small companies studied may qualitatively consider the long-term benefits
 of pollution prevention  investments, their use  of simple payback  as the primary or  sole
 indicator of an investment's return reflects their short-term financial perspective.  The Paper
 Coating and Diversified  Chemical Companies  indicated that a time  horizon pf  10 years is
 typical for evaluation of major investments.  In the case of the Paper Coating Company, the
 need  for extending this  figure to 15 years to capture estimated  liability avoidance for the
 project analyzed became  evident in preparing the TCA analysis.
 RESULTS

        In  two  of the in-depth  analyses, the  inclusion of waste  management,  regulatory
 compliance, future liability and other previously  unquantified costs  in  the  TCA Analyses
 resulted in a net improvement in project cash flows  and financial indicators as compared to the
 Company Analyses.  Table ES-2 summarizes these results.

 The magnitude  of the effect, as illustrated by the percent change in IRR  (years 1-15)  ranged
 from a low of-5% for Project 1 to 3% for Project 2.  The 15-year NPV difference is more
 dramatic, extending from a low of -94% for Project 1 to a high of 33% for Project 2. Only
 in the case of Project 2 are the financial  indicators noticeably improved by the TCA; payback
 is reduced from 4.3 to 3.8 years and the 15 year NPV is 33% higher than  for the Company
 Analysis.  The  degree of change was determined principally by the cumulation  of  annual
 operating costs  and benefits added to the TCA, and, to a lesser degree, the addition of  capital
 costs which were not accounted for in the Company Analysis.  With respect to future liability,
 the impact of this cost on a financial indicator depends on the size of the estimated liability,
 the projected year in which  it will occur, and the discount rate used in the calculation of NPV
 and IRR.

 Consider the results for Project 3, for which only  NPV changed significantly.  We see that
 much depends on the  original capital cost of the project, the completeness of the company's
 own  analysis,  the magnitude  of indirect savings, and  when such  savings  occur.   And,
 surprisingly, as  illustrated by Project 1, TCA is as likely to turn up additional costs as savings,
 which can  actually diminish the attractiveness  of the  prevention  investment  to the firm!
 Moreover,  the effort expended  in preparing the TCA analysis, though partially attributable to
 startup costs of  any new practice,  was substantial enough to make even large  firms weary of
 adopting such an approach for all projects competing for capital resources.

       The  limited number of cases included  in this  study precludes generalizations  about
 overall corporate receptivity to TCA approaches and the degree to which pollution prevention
 will be accelerated by its adoption.   In general,  we adopted a conservative approach  in this
 study, in the sense  that only the most obvious and quantifiable  costs were incorporated in the
 TCA  analyses.   Thus,  the gains from applying a TCA versus a company  approach should be
regarded as low range estimates.  Within the limitations of our  study, however, it is clear that
TCA  can serve as a valuable tool for translating discretionary judgements  into concrete dollar

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  values  during the capital budgeting  process.  Insofar as pollution  prevention  projects are
  particularly prone to less  tangible and indirect costs and benefits, TCA equips  managers to
  develop a more precise estimation of the real financial returns to such projects.  Though TCA
  does not a priori ensure an  attractive profitability  level for prevention  projects, the cost
  characteristics of such projects suggests that their financial  performance in general will  be
  enhanced by TCA.  This is likely to be particularly true for industrial  prevention projects that
  are materials  and process-focused, and occur upstream in the production process.   Over the
  longer  term,  TCA  could  serve as a substantial  force in. transforming the "must-do" and
  "inherent loser"  image of environmental projects into a more  positive,  profit-adding and
  market-expanding image.

        Inducements to TCA adoption may take the form of incentive,  educational, or training
 programs. Incentive programs may include expediting facility permitting for those  firms which
 adopt and demonstrate the application  of TCA methods beyond  the requirements contained in
 the recently enacted New Jersey Pollution Prevention Act.   TCA training seminars, with
 specialized modules aimed at large, medium and  small-sized  firms, may be offered by DEPE.
 These programs  may  be  offered  in conjunction  with trade  and  business  associations,  and
 customized to a particular industry or product-line where appropriate.   In addition, expanded
 direct assistance  to individual  managers,  of  the  type currently offered by the New  Jersey
 Technical Assistance Program,  may be offered as follow-up to such seminars.

       To supplement incentive programs, mandatory pollution prevention plans required under
 the Pollution Prevention Act set forth minimum cost and benefit items  for inclusion in project
 financial anslyses.   Firms must justify  why  a financially viable prevention projeci  is not
 undertaken.    The  aim is to  catalyze  corporate  self-interest  in pollution  prevention  by-
 demonstrating  profitable opportunities which might otherwise  go unnoticed or underestimated.
 Even with such demonstration, of course, prevention investments  cannot  be assured since
 bottom-line financial indicators  are but one among several determinants of allocation decisions
 within a firm's capital  budgeting process.

       Finally,  while a particular TCA  method  is not a  prerequisite  to the adoption of a
 pollution prevention approach, a user-friendly  method can  simplify and expedite the  analysis
 and  comparison  of projects.  No one  TCA method  is suitable for all firms.   A successful
 strategy  will present firms with a menu of tools from which to choose. Such methods may
 include those previously  developed,  the  P2/FINANCE  method  developed  for this study,  or
modification of existing analytical fools currently used by individual firms.

       Choosing among TCA promotion strategies must flow from broader policy positions
affecting  how  vigorously the state  wishes to  be involved in shaping the capital" budgeting
process which  is traditionally  viewed as the sole prerogative of the firm.  Regardless of how
aggressive a state program is, the success  of TCA  ultimately depends on the degree to which
managers believe that TCA is, above all, an aid to greater profitability in business operations.

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  Table  ES-1.   Cost Inventory:   Company  Versus TCA Analyses
 X » Costfs) Included                     Project  1'
 P ** Costfs) Partially Included     Company

 Capital Costs

 Purchased Equipment              X
 Materials (e.g. Piping, Elec.)
 Utility Systems
 Site Preparation
 Installation
 Engineering/Contractor             X
 Start-up/Training                  X
 Contingency
 Permitting
 Initial Chemicals
 Working Capital
 Salvage Value
 Other:
         Project Audit

 Operating Costs
 Direct Costs:4
 Raw Materials/Supplies            P
 Waste Disposal                   P
 Labor                           X
 Revenues - General
 Revenues - By-products
 Other
         Transportation

 Indirect Costs:5
 Waste Management
         Hauling
         Storage
         Handling
         Waste-end Fees/Taxes
         Hauling Insurance
 Utilities
         Energy
         Water
         Sewerage  (POTW)
 Pollution Control/Solvent Recovery
 Regulator)' Compliance
 Insurance
 Future Liability
Notes:
                                         X
                                         X
                                         X
                                         X
                                         X
                                         X
                                         X
                                         X
                                         X
                                         X
                                         X
                                         X
                                                         Project 22
                                         TCA    Company



                                         X      X

                                         X
                                        .X
                                         X
                                                 X
                X

                X



                X
X
P
X
X
X
X
X
                X
X

X
X
X
                                 Project 33
                 TCA    Company
                         X
                         X
         X

         X
                                                                         X
X
X
X
X
        X
                         TCA
                         X
                         X
                X

                X
X
X
X
X
                                                                                         X
                                        X
                                        X
1.
2,
3.
5.
Solvent/heavy-metal to aqueous/heavy metal-free coating conversion at Paper Coating Company
Paint/water separator at Metal Fabrication Company
Byproduct recover)' project at Diversified  Chemical Company
We use the term "direct costs" to mean  costs which are typically allocated to a product or process line (i.e.
not charged to an overhead account) and are typically included in project financial analyses.
We use the term "indirect costs" to mean costs which are typically charged to  an  overhead account and
typically not included  in project financial analyses.

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-------
       Originally presented  at the  1995 TAPP1 International  Environmental Conference  May 7-10  Atlanta  GA
       Copyright TAPP1 1995
   ENVIRONMENTAL    ACCOUNTING:
   PRINCIPLES   FOR  THE  SUSTAINABLE
   ENTERPRISE
  A.L. White, Ph.D.
  Senior Scientist
  TeUus  Institute
  Boston MA 02116

  A. Dierks
  Research Analyst
  Tellus Institute
  Boston MA 02116
  ABSTRACT
D.E. Savage, Ph.D.
Research Associate
    Tellus Institute
 Boston MA 02116
 Three case studies from large manufacturing firms illustrate
 the importance of good environmental cost accounting  in
 the realm of project financial analysis for capital budgeting.
 The environmental projects described encompass capital
 budgeting initiatives on three  levels:  1) Jhe facility level;
' 2) the divisional level; and 3) the corporate: level.

 Although the original motivation for each cast study was
 recognition  of the need  for  a comprehensive,  accurate
 capital budgeting analysis for  the environmental proposal
 under consideration, two of the analyses also identified aad
 quantified, in dollar terms, the strong connections that exist
 between  environmental  projects  and  broad  issues  of
 integral interest to firms, such as production flexibility and
 capacity,  and  environmental   liabilities.  As such, these
 studies provide valuable  insights into the scope,  sources,
 and application of environmental cost information within
 the firm, and how improvements in each of these areas can
 play an important role in supporting rational management
 decision-making.
Key  conclusions  emphasize   the  necessity  for  good
materials  accounting  as a basis for good  cost accounting,
and the importance of adequate treatment of probabilistic
  MEASURING TO MANAGE

  Industry managers face a disturbing and growing dilemma
  when it comes  to environmental costs.  On  the one ,hand,
  regulatory requirements,  voluntary standards,  and  market
  pressures continue to impose continually higher, and more
  costly, demands for environmental  excellence.   On the
  other hand,  the  information  essential ,-to  fashioning  a
  rational  response   to  such   expectations  is  typically
  unavailable in a timely, rigorous, and consistent way. The
  result:   decisions on capital  projects,  materials choices,
  product pricing, and product  mix often serve  neither the
  best  interests  of  the  firm  nor,  in  many  cases,  the
  environment.

  What are the root causes  of this dilemma?  At least four
  are identifiable,  linked  to both the nature of traditional
.accounting systems and the nature of environmental costs
  themselves.'    First,  traditional  accounting  systems  are
  geared  partly  to compiling and preparing information  for
  external reporting and disclosure, e.g.  annual  reports to
  stockholders or 10-K filings to the Securities and Exchange
  Commission  (SEC).   In  serving to profile the  overall
  financial performance in a digestible form while protecting
  competitive   information,   such  information  must  be
  aggregated.     For  industry   managers   charged   with
  environmental  performance,  as  well  as  day-to-day  or
 month-to-month  production,  pricing,  and  product mix
 decisions, conventional aggregated financial information is
 of minimal value.

 Second, many  environmental costs traditionally  have been
 lumped  into  pooled,  or   overhead,  accounts  that  are
 detached from the products and processes  responsible for
• creating costs in the first place. When costs are uncoupled
 from the activities that generate them,  managers are faced
 with incomplete or distorted information which cannot help
 but k,ad to suboptima! decision-making.  Of course, unless
 incentives  for  improved  cost allocation  are put in place,
 shifting  pooled environmental  costs to specific products
 and processes  may  be unwelcome  to managers  who
suddenly see  a product line looking less profitable than
 otherwise thought.

Third, many environmental  costs are contingent and subject
to substantial margin., of errors.2   These  attributes  are not
unique to  environments! costs,  but  it is fair to say that

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environmental  costs  often represent  the extreme case in
comparison to labor,  equipment,  materials and other more
certain items which comprise the manager's cost calculus.
Liability  in its  various forms  —  Superfund,  property
damages, natural resource damages — is the  classic case.
In the normal course  of business  planning, such costs arise
only when something goes wrong and the firm is deemed
liable by a regulatory body or court of law.   If and when
such  costs  materialize  is difficult to  predict with  any
degree of reliability.  Yet to pretend  they do  not exist, or
never will,  is neither acceptable  to the  SEC  nor prudent
practice for the responsible manager.  Liability is not alone
among   environmental   costs  in  this  regard.    Future
regulatory  compliance costs, revenues generated  through
tradable  permits  for  criteria  or  air toxic pollutants,  and
shutdown costs owing to sudden environmental releases are
other examples of environmental  costs whose timing,  and
magnitude are  equally difficult to assess.

Fourth, the foundation of an  accounting system capable of
delivering useful environmental information to managers is
a sound  system of materials  accounting.  Distilled to its
basic   element,   environmental   management   in
manufacturing  industries is about materials management -
materials use, processing, release  into the environment,  and
final disposition or reclamation  once the useful life of a
product is ended. At each step of the product cycle, these
activities may result in costs  via low yields or other forms
of production  inefficiencies,  the  costs  of effluent  and
emissions controls and prevention,  Superfund  and product
liability costs, and other less tangible, hidden, or indirect
costs.  In this fashion,  the  sibling relationship between
materials accounting  and cost accounting lies at the heart
of effective  environmental management,  and is integral to
shaping  the  next  generation  of  accounting   systems
supportive of corporate environmental improvement goals.
Unfortunately,  the implications  of  this  critical  linkage
normally does  not receive the recognition or follow-up it
deserves.

EXAMPLES FROM CAPITAL BUDGETING

The measure of quality  of any accounting system  is how
effectively  it delivers  information  to  the users for the
purposes  for  which it is  designed.    Environmental
accounting is no exception.   It is  simply  the application of
sound accounting practices to decisions  which are. to first
order, inherently environmental — e.g. how best to reduce
air toxic emissions ~ or. alternatively,  are not primarily
environmental  but contain  a significant environmental
dimension — e.g. the decision to relocate  and consolidate
the production  of intermediate  materials  when  such  a
decision  will enable both production efficiencies and cost-
effective waste management  opportunities.  Thus, by this
definition,  environmental  accounting  serves a wide range
of management  decisions, including:  determining  optimal
product mix  and process  designs; assessing the priorities
and  economics  of waste   management  and  pollution
prevention  options;   benchmarking   environmental
performance at the same facility over time, across facilities,
or in relation to industry-wide performance; and bringing
true costs to bear on pricing  decisions.

Recent case studies of capital budgeting of environmental
projects among  large U.S. firms demonstrate some of the
shortcomings  of conventional  accounting  practices  and
directions  for  their  improvement.    We illustrate  by
considering projects at three  levels:  (1) the facility level;
(2) the divisional level; and (3) the corporate level.  These
examples provide valuable insights into the scope, sources,
and applications  of environmental  information, and how
improvements  in  each of these  areas  plays  a  role  in
rationalizing management  decision-making.

Facility Level

The first case is drawn from experience at a specialty paper
mill, which produces a variety of uncoated, on-machine
and off-machine coated  papers,  carbonizing,  book  and
release base paper.3  The coating  used is a latex (i.e. non-
solvent)  formulation containing  clay, styrene  butadiene,
starch, and polymers.   The case study compared a typical
Company financial analysis  with a more comprehensive
Total  Cost Assessment (TCA) of the  proposed  project.
TCA is an approach to capital budgeting for environmental
projects that  comprises four  elements:   (1) an  expanded
inventory of costs, savings, and  revenues  to capture less
tangible   and   indirect   effects   of   an  environmental
investment; (2)  allocation of costs to product  or process
lines  instead of overhead accounts;  (3) expanded time
horizons for  purposes  of  estimating profitability;  and (4)
use of appropriate and  multiple financial indicators  to
accurately  characterize project profitability.

Papermachine white water, a mixture of water and residual
fiber and filler (clay and calcium carbonate) that drains out
of a sheet of paper as it travels across the paper machine,
is typically captured by a white  water collection system
dedicated  to  a  single papermachine.    As  a pollution
prevention measure  to reduce water  use and wastewater
treatment,  white water may  be  passed through a saveall
screening device to separate fiber and filler from water;
fiber,  filler and water are  then  recycled  back into  the

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  system. The saveall produces a clear stream  of water that
 . can be used in numerous papermachine operations.

  In this mill, two paper machines, sharing a common white
  water system, produced  a  variety of paper grades made
  with either acid,  neutral, or alkaline sizing  chemistry."
  [Machine 1 had a saveall system that filtered fiber and filler
  prior to discharging into the joint white water system. This
  material was  recycled back into the papermaking system.
  When the machines  were using different sizing chemistry,
  the  mixed  white water  from  both  machines  was  not
  reusable, and  had  to be sewered.  Under these conditions,
  a large  flow of  potentially  reusable water from both
  machines, and fiber and filler from Machine 2, was lost to
 the sewer.

 Prompted  primarily  by the lack of spare water effluent
 pumping capacity,  the mill commissioned  a study to better
 understand  the white water  piping system.  The resulting
 report contained detailed engineering drawings of the fresh
 water,  white water, and paper  machine systems and two
 recommendations  for process modifications.

 The first recommendation  was the  installation  of a second
 saveall to capture fiber and filler from  Machine 2.  Under
 the second  recommendation,  the  white  water  systems
 would  be  split,  so  that  each  machine  would  have  a
 dedicated system.  This would require installation of i new
 pump, piping, and controls.  In combination, these system
 modifications would permit fiber, filler and water reuse an
 both machines  at all times and would minimize Biological
Oxygen  Demand  (BOD) and solids in plant wastewater.
       Company  Analysis  consists of the required capital
  costs and only those operating costs and savings that the
  company typically includes in project financial analyses for
  projects of this type.  The TCA contains these and  other
  operating costs and  savings, which were developed in the
  course  of the case study.   In this white water/fiber  reuse
•  project, a number of cost  items appear in the TCA which
  are either partially or entirely omitted  from the  company
  analysis.   These  include  savings  in raw  material  costs
  owing to recovery of fiber and  filler;  a savings  in  fresh
  water usage and costs, and  associated  fresh water treatment
  and  pumping;  a savings  in energy  use for fresh  water
  heating;  and  a  .savings  in   wastewater   pumping  and
  wastewater treatment fees.

 -Table I  shows the financial impact  of the omitted savings
 by comparing the Company and TCA profitability analyses.
 This project, with a capital  cost of SI.47 million, yields an
 annual savings of S350.670 with the Company Analysis,
  versus $911,240  in the TCA.  Net Present Value  (NPV)
  over a 15-year time horizon jumps from $360,301 to $2.8
  million. And Internal  Rate of Return  (1RR) over 15 years
  increases  from 21%  to 48%.   At  the  same  time,  the
  payback period declines from 4.2 to 1.6 years.

  The project did not affect wastestreams that require on-site
  management or disposal, nor did it affect any  regulatory
  compliance  activities  at  the site, therefore the financial
  analysis did not  include  costs  for these activities.   In
  addition,  no  impacts  on  revenue  were  expected  since
  neither product quality nor production rates  would  be
  improved,  nor did the  mill  expect to visibly enhance  its
  product or company image.   Finally, no tangible  impact  on
  avoided future liability was  expected  for this project.  In
  sum,   the  TCA/Company   differential  in  profitability
  occurred in  a  pollution prevention project  involving a
  relatively  straightforward,  proven  technology,  and was
  substantial  even without inclusion of some of the  more
  indirect, less tangible financial benefits  that may well  occur
 with more complex and hazardous production technologies.


 Table I.  Summary of Financial Data for White Water
.and Fiber  Reuse Project

                 Company 'Analysis       TCA

 Capital Costs        $1,469,404   -     $1,469,404
 Annual Savings      $  350,670        $  911,240
 Financial Indicators
•NPV Years 1-15     $ 360,301
 IRR Years 1-15          21%
 Simple Payback (years)    4.2
                                                                                                $2.851,834
                                                                                                      48%
                                                                                                      1.6
                                                          Divisional Level

                                                         .This  case  study  was   performed   for  the  chemical
                                                          manufacturing   operations   of  a   multinational   high
                                                          technology  firm  and  illustrates  the  integral connection
                                                          between pollution prevention and general production issues
                                                          such as production planning, capacity, and flexibility at the
                                                          division's two major facilities.5

                                                          The project involved the financial analysis of the costs and
                                                          benefits  of completing  a batch  still  solvent  recovery
                                                          system,  which  was  halted mid-way  during  construction
                                                          because of cash flow constraints.  During the construction
                                                          delay,  which  lasted  several   years  due  to   ongoing
                                                          competition  for capital funds, facility production  "plans

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 changed, clouding the question of how many waste streams
 on site would be suitable for batch  still recovery.   This
 uncertainty in the annual  raw material and waste disposal
 savings resulting from an  on-site recovery still, in addition
 to the elapsed construction down-time, made it necessary
 to  revisit the original  financial analysis  of the project
 before management approval for still completion could be
 sought.

 As in the prior facility level case, we again approached the
 project analysis using a TCA  framework: a comprehensive
 cost/benefit  inventory,  accurate cost allocation to  the
 production processes involved, a long analysis time horizon
 (12 years), and use  of financial  indicators which take into
 account  the time value  of money.  The issue of the time
 value of money was particularly relevant to this project
 because  of the significant delays in completion  of project
 construction.   P2/FINANCE,  a  spreadsheet software tool
 developed earlier to handle  pollution prevention project
 financial  analysis,  was  modified to handle these delays.
 Capital costs  were  relevant to both of the final decision
 options  of 1)  canceling  the project permanently and
 writing-off and depreciating the previously expended  funds
 and 2) approving project completion, which would require
 new capital expenditures.

 The firm's environmental staff requested a special focus on
the  issue of  cost- inventory   and   the  possibility  of
 quantifying less  tangible items such  as  future   waste
 disposal  costs and potential liabilities,  items often omitted
 or left unquantified in project evaluations.  We investigated
the implications of these issues  to project profitability by
mapping all of the waste streams designated  for the batch
still  from  production to  final fate.   The fates of these
streams included treatment by multiple, sequential vendors
and some landfill disposal in both  the U.S.  and Canada.
After  this  exercise,  it  became clear  that,   with one
exception, most waste  management  costs  —  transport,
treatment, disposal,  as well as manifesting and related on-
site activities  — were not  significant enough  to  materially
affect project  profitability. Rather  than spend  additional
staff resources  on refining estimates  of such  costs, and
potentially diverting upper management's  attention  away
 from  a more  critical issue  in  its decision-making,  we
decided to terminate efforts  at further quantifying  waste
management  and liability  costs.

The  more critical  issue to project justification was the
effect of the proposed project on production  capacity and
 flexibility, the full impact  of which only gradually became
evident    during  the   course   of   data   development.
Specifically, a major intermediate product, which is usually
purchased from another firm, was being considered for on-
site production, either at the batch  still site or at another
company  site  in  the  same  state.  Consideration  of the
several  waste streams from  this potential production line
(cumulatively  called  Stream   X  in  Figure  1) had  a
significant effect on the financial analysis of the batch still
project.   The  base case Internal  Rate of Return (1RR)
increased  from approximately  4% to 21% upon inclusion
of these waste  streams.  Moreover,  company  staff did not
consider adoption  of the  new production process to  be
feasible in the  absence of a solvent recovery  system that
would reduce production costs via waste disposal savings
and raw material recovery.

Further complicated  by  air  emission  regulations  and
technical  issues, solvent still  capacity  limitations  at  the
second   production   site,   and  production   technical
uncertainties, the final analysis of the batch  still evolved
into a series of financial scenarios.  As illustrated in Figure
1, the  scenarios   represent  different  configurations   of
product mix (and therefore wastestream mix), production
sites, waste stream fate in the absence of a batch still, and
levels  of  future  capital  expenditure required for project
completion.   These  scenarios  serve  to  pinpoint  major
decisions  facing division management, particularly in the
area of production planning.  How much, where, and when
should  production  of  intermediate   chemicals  occur?
Convinced  of  the  integral  role  of the solvent recovery-
system in such  planning, the environmental and production
staff,   in  almost   unanimous  support  of  the  project,
proceeded to resolve production and other uncertainties  in
preparation   for  the  funding  approval  process.    The
questions  raised by scenario analysis,  and the substantial
staff effort spent on answering them,  eventually paid off.
In December 1994, upper management  approved funding
for completion  of the batch still project.

Corporate  Level

Our  third  case centers  on  an  issue  at the  forefront  of
management concern  for  more than a  decade:    the
characterization,  measurement, and reduction  of liability.
Yet,  as is  often the case  in  environmental  accounting,
initial   perceptions   of  key  management   issues   are
transformed  during the  course of cost identification and
analysis.  In this instance, such  an  evolution  occurred  as
production  shutdown costs associated  with a transformer
fire or spill emerged as a second significant contingency
cost  in  addition to the usual liability costs for Superfund,
personal, and property damages.

-------
   Our case involved  the  environmental division  of a large
   manufacturing firm, which  was seeking to implement an
   accelerated   corporate-wide   PCB transformer  phase-out
•.   program. The  proposal  was  not  a  new   one;  earlier
   initiatives to obtain funding for this project  did not succeed
   because  of the staffs inability to justify  the project  on
   financial grounds.  Because  the project would require tens
   of  millions  in  capital  to replace all PCB  transformers
   within a five year  accelerated  time frame (versus  an
  otherwise  expected  time   frame of 30  years),   upper
  management required financial justification beyond what
  had been put forward in earlier appropriations requests.

  In an earlier analysis of a similar PCB phase-out proposal,
  the   liability   costs  associated   with  retaining  PCB
  transformers  on-site  were based on  a report  by the  U.S.
  Army Corps of Engineers6,  which assumed as one of its
  costs  a  catastrophic  failure cost of $85,000  for each
  transformer  in its fortieth year of service.  These costs
  were the source of much contention  during  the  previous
  capital  budgeting cycle; many employees  questioned  the
  accuracy  of these liability costs and therefore  the validity
  of the capital  request.    Due  to  this  earlier  debate,
  management  decided  to  invest substantial effort  in  the
  development  of defensible  liability  costs.   These,  then,
  were the  focus of our analysis.7

  Two approaches that may serve as the basis  for  cost and
  probability   estimates  are   engineering   and  actuarial
  techniques.   Engineering-based liability estimation uses a
  model in which the estimated failure of each component  in
 the system yields a risk of an event (e.g. the probability of
 failures  of component X, Y and  Z in the factory chain
  leading  to a  nuclear  plant accident).   On the other hand,
 actuarial-based  estimation  uses  a  subset  of historical
 information  relating to the event to calculate risk (e.g. the
 annual  number of nuclear  facility  shutdowns  per  total
 number  of facilities   for the last  ten years).   By using
 historical  information for this case study, the defensibility
 and accuracy of liability cost estimates is enhanced due to
 the method's  reliance  on  historical facts  rather  than
 engineering  (or theoretical) estimates.

 We began thinking about liability costs by developing a
 framework to incorporate  the relevant costs, as shown as
 Figure 2.   By  mapping the  possible  ramifications of an
 acute event, one  can   begin to characterize  the necessary
 data and consider potential data sources.  In this  instance,
 we determined  that the  most significant costs associated
with an acute event would be  related to cleanup, litigation,
 insurance,  and business shutdown.  For this  case study we
considered two acute  PCB events:  a transformer fire and
  a transformer spill. Separate data sets were developed for
  these  incidents owing to their different probabilities and
  costs.

  As shown in Figure 2, all of the costs associated with an
  acute  PCB event are contingent on the probability of that
  event (A). For this study, the probabilities of a transformer
  fire and spill were developed from historical databases .and
  equal  0.000018 and  0.0034 events  per transformer-year
  respectively8.  Each  acute event requires  some cleanup,
  with an associated cost (B) equal to approximately  $7.8
  million for   a  transformer  fire  and   $100,000  for  a
 transformer spill.  Mediating these costs by the probability
 of the event's  occurrence leads  to  an  annual  cost per
 transformer year of $140 for a transformer  fire and $339
 for a transformer spill9.

 Beyond cleanup, an acute event leads to the potential for
 third party litigation (C) and its associated  cost.  For this
 cost  item, historical   information10  was combined  with
 internal (i.e. company) estimates to generate  the following
 annual  costs  per transformer-year:  $68 for  a  transformer
 fire and $3,213 for a transformer spill.

 Further, an acute event or third  party litigation may lead to
 increased insurance costs (D) for the firm. Thus, insurance
 effects  may  be a function of three probabilities  (i.e.
 probabilities of event, litigation  and insurance effects).  In
 this case  study, insurance  costs were  not  likely  to be
 impacted  by  third-party  litigation  because  the  firm  was
 self-insured and  therefore were  not considered further.

 As vrs  proceeded with an assessment  of liability costs, a
 second  cost implication emerged -- production shutdowns
 or  slowdowns  owing  to  interruptions   in  the flow  of
 intermediate  inputs  in  the  firm's  vertically-integrated
 production  chain.   Losing even one  day of  production
 could trigger a significant loss of revenues to the firm  if it
 results in a loss of sales output or significant costs to make
 up that  production.

 These shutdown costs, depicted  in Figure 3, depend on the
 firm's  production level,  inventory, worth of output,  etc.
 They are measured  by the probability of the acute incident,
 the probability that this incident results in lost  production
 and the cost of the  shutdown per day.  After facilities that
depend  on  inputs from the shutdown facility have depleted
their inventory, they too must shutdown, seen in Figure 3
as the secondary effects.   These effects are characterized
by the  probability  that the primary facility  is depended
upon  by secondary facilities,  the  number  of secondary
facilities, plus a measure  of the  inventory available to the

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 secondary facilities. For this case study firm, the shutdown
 cost of a transformer fire equals S10 per transformer-year,
 whereas  the shutdown  cost  of a transformer spill equals
 SI,560.

 Aggregating all of the costs  (i.e. cleanup,  litigation,  and
 production effects) associated  with  acute incidents, gives
 the total  costs associated  with acute incidents, as show in
 Table II.

 As an example, the above totals indicate that a firm using
 200 PCB transformers could save $1,066,000 annually in
 contingent  costs  if it replaced those  PCB  units.  These
 contingent  costs  reflect the  firm's liability, or risk,  of
 continuing   to  use   PCB-containing  transformer   units.
 Although  it is  impossible to definitively assess  a firm's
 liability (e.g. a transformer fire could happen in the current
 year or it could  never happen), actuarial-based  liability
 estimation aids management  in planning for the future by
 incorporating reasonable estimates of contingent costs.
 Table II.  Total  Contingent  Costs Per Transformer-
 Year Associated  with a PCB Transformer
* Total cost of transformer fire
• Total cost of transformer spill
cost per unit-year

        $ 218
         5,112
LESSONS  LEARNED

What lessons may be culled from our three case studies?
Are there themes that emerge that may inform  future
initiatives  in the design  of environmental  accounting
systems, which  are compatible  with  and serve to advance
the  goals  of  sustainable   development   in   corporate
environmental management?  Our case studies are limited
to only one function of environmental accounting, namely,
decision support  of project profitability  analysis  in the
context  of capital budgeting.  As  we noted at the  outset,
many  other  functions  are  served  by  environmental
accounting,   e.g.  product  mix  and  pricing  decisions,
monitoring and  performance evaluation, and the  design of
incentive systems  to encourage environmentally-innovative
behavior among staff.  Notwithstanding  our focus on the
project evaluation  function, we point to several themes that
may assist in the  design and/or modification of  corporate
accounting   systems   to  support  environmentally-wise
decision-making.
 1. Effective cost accounting requires effective materials
 accounting. This point, noted in our opening observations,
 cannot be  overstated.   Environmental  costs  arise when
 hazardous materials are used, processed,  and/or released  as
 non-product outputs, and understanding  material  flows  as
 they move through a production system is a prerequisite  to
 identifying and   tracking  environmental   costs.   Mass
 balances  are the  most rigorous  basis for developing such
 information, but short of this,  materials  accounting  and
 process flow diagrams may well suffice.  As the first case
 study  of the paper  firm amply demonstrates,   a  single
 omission  or error in defining relevant materials or energy
 flows can create major cost consequences that may lead  to
 misguided management decision-making.  Moreover, as the
 second (batch  still)  case  study  demonstrates,  sound
 materials  accounting — in this case,  tracking the flow  of
 different  waste streams  to  their ultimate  disposal site  —
 also  serves as  a  useful  screening  device  to  avoid
 unnecessary expenditures of staff resources on estimating
 environmental  costs  that  are   relatively  insignificant
 compared to other project costs.

 2. Key environmental costs  are contingent  in  nature;
 environmental accounting  systems must  be designed to
 handle such contingencies.  Cases 2 and  3 illustrate this
 critical point.  Many, perhaps most, "environmental costs"
 are contingent, or probabilistic, in nature.  They are driven
 by  future  conditions  or  events  with  uncertain,  but
 estimable,   probabilities   and   cost   outcomes.    Future
 regulatory compliance  and liability for Superfund, personal
 or property  damage are examples. Conventional  financial
 accounting practices are not designed to handle contingent
 costs;  in  fact,  contingencies  are  generally  avoided  in
 financial reporting and where  they do appear, are subject
 to strict standards  for estimation  and  disclosure (as in the
 case of SEC rules).  But such standards have  little to do
 with environmental costs for purposes of internal, decision-
 making.   Effective environmental accounting requires an
 awareness  of this  critical difference and a  willingness to
 experiment  with  different  methods  for  dealing with
 contingent costs.   Scenario analysis  of the sort  used  in
 Case 2 and actuarial-based cost estimation such as in Case
 3  point to  two  approaches to  handling  the  inevitable
uncertainties associated with environmental costs. Tools
such as these are  an integral part of any  environmentally-
conscious  cost accounting system.

3. Improvements  are  likely to  be incremental  and
 piecemeal.   There  is no single system  that serves all
purposes in all firms.  Those seeking such a definitive,  all-
encompassing  solution  are  likely  to  be disappointed.
 Because environmental cost information serves so  many

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  different functions  in the organization, the  "system"  is
  better thought of as a set of adjustments to current  cost
  accounting  systems, all with the purpose  of identifying,
  tracking, and  reporting  environmental  information  to
  sharpen  management  decisions.   In Cases 1 and 2, such
  adjustments took the form  of, respectively, more rigorous
  process flow information and characterization of alternative
  production  systems  configurations.   Neither  of these
  required  overhaul   of existing  practices,  only greater
  attention to detail and to bundling feasible "packages" of
  where,   what,  and  how  much   intermediate   product
  manufacture might occur.  This amounted to nothing more
  than sound management  and engineering practices applied
  to environmental projects.

 4. Improved  environmental  accounting is not  full cost
 accounting.   Our  cases  demonstrate  an assortment  of
 initiatives  to  better   identify  and   estimate  internal
 environmental  costs  to  enhance  project   profitability
 analysis.   But internal costs are,  by definition, limited to
 those with measurable  financial consequences to  the firm.
 They do not include environmental costs that accrue to
 identifiable third parties or to society as a whole, such as
 the cost of biodiversity loss owing to unsustainable forest
 practices  or wetlands loss, global warming owing to carbon
 emissions, or  forest, crop or building  damages linked to
 acid  rain deposition.  Full  cost accounting in its strictest
 sense would encompass such costs.  While the direction of
 environmental  regulations  and international  accords  and
 standards is to extend the cost net outward to internalize
 such  external  costs, few firms  today  are preparing to
 voluntarily move in  that direction.  Although our cases
 suggest that much work remains to get  internal corporate
 environmental  costs  in order, the anticipatory firm will
continuously look beyond such costs and design into its
managerial accounting system the  capacity to track the full
range of environmental costs, both internal and external.
  REFERENCES

  1.    Todd,  R.,  "Zero-Loss  Environmental   Accounting
  Systems",  in  B.  R. Allenby and D.J.  Richards (eds), The
  Greening  of Industrial Ecosystems,  National Academy
  Press, Washington, D.C., 1994, 191-200.

  2.   White,  A.,  EPA  Journal, "Accounting  for Pollution
  Prevention", July-September (1993), pp. 23-25;  White, A.,
  Becker,  M.,   Goldstein,   J.,   Total  Cost   Assessment-
  Accelerating  Industrial  Pollution  Prevention  Through
  Innovative  Project  Financial Analysis, With Applications
  to the Pulp and  Paper Industry, Prepared for U.S. EPA,
  Office of Pollution  Prevention, December  1991.

  3.  Excerpted from  White, A., Becker, M.  and Savage,
  D.S., Pollution Prevention Review, "Environmentally Smart
 Accounting:   Using Total Cost Assessment  to Advance
 Pollution Prevention"  Summer 1993: 247-259.

 4. Sizing is added to pulp to reduce water absorbency  in
 the final  paper.  The  Ph (i.e.  acidity or alkalinity)  of the
 pulp  must  be adjusted according  to  the  type of paper
 desired and  sizing used.

 5.  Savage,  D.E., and  White, A.L.,  Pollution Prevention
 Review, "New  Applications  of Total  Cost Assessment:
 Exploring the  Prevention - Production  Interface",  Winter
 1995  (forthcoming).

 6. U.S. Army Corps of Engineers.  The PCB Transformer
 System.

 7.   Data  in the following  discussion  is  modified  as
 appropriate  for confidentiality reasons.

 8. Information on the probability of acute PCB events was
 collected from  two sources:  (1) the Emergency Response
 Notification  System  Spill Database;  and (2) an internally-
 developed database on acute PCB-transformer  events.

 9.  Cleanup costs were developed  on the basis of two
sources:   (1) Final  Report  for  Task  1-04:   PCB Spill
Cleanup Policy Evaluation by Alexa Fraser and  Stephen K.
Dietz  of Westat,  Inc. in December 12,  1988; and (2) the
 internal database on  acute PCB-transformer  events.

 10. Litigation costs were developed using a subset of Jury
Verdict Research's personal  injury  database  relatin"  to
chemical exposure and industrial accident suits.

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             Figure 1. Batch Still Scenarios
                    Typical past production schedule
                     Analysis time period: 12 years
 Base Case
 (Streams A,B,C)
                           NPV
                   IRR
 -$1,441,000       + 4%
 Payback

 9.6 years
 Stream A to Kiln
(Streams A,B,C)
 -$ 756,000       + 8%
7.2 years
Reduced Capital
(Streams A,B,C)
 -$  88,000       +11%
5.7 years
Stream X
(Streams A,B,X)
+ $ 2,066,000       + 21 %      3.6 years
Combination of
Reduced Capital
and Stream X
(Streams A,B,X)
+ $3,419,000       +33%
2.1 years

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              FIGURE 2. CONCEPTUALIZATION OF LIABILITY COSTS
                          P(acute event)
     ((Cleanup)
P * Probability of the event
$ = Cost associated with the event
P(3rd party litigation) * $(3rd party litigation)
                                                P(insurance increase) * $(insurance increase)
            FIGURE 3. CONCEPTUALIZATION OF SHUTDOWN COSTS
                               P(acute event)
                                                        Primary Effects
             P(lost production 0 days, 1 day...n days) * $(shutdown/day)
                       After the nth day of lost production
                                                              Secondary Effects
   P{lost production n+1 days, n+2 days...n+z days) * $(shutdown/day) * (# of primary
       plants affected + (P(secondary plant) * # of secondary plants affected))
P s Probability of the event
$ = Cost associated with the event

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         REVISED EXECUTIVE  SUMMARY

                          JUNE 1993


                TOTAL COST ASSESSMENT:

ACCELERATING INDUSTRIAL POLLUTION PREVENTION

THROUGH INNOVATIVE PROJECT FINANCIAL ANALYSIS

           With Applications to the Pulp and  Paper Industry


                          Prepared for:

                U.S. Environmental Protection Agency
               Office of Policy Planning and Evaluation
                    Office of Pollution  Prevention


                              By:

                      Allen L.  White, Ph.D.
                      Deborah  Savage, Ph.D
                         Monica Becker
                       Risk Analysis.Group
                         Tellus Institute
                       11 Arlington Street
                     Boston, MA 02116-3411
                        Tel: 617-266-5400
                        Fax: 617-266-8303

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 PREFACE

        This Executive Summary supercedes aversion originally published in a December 1991
 report to EPA entitled: Total Cost Assessment:  Accelerating Pollution Prevention Through
 Innovative Project Financial Analysis, With Applications to the Pulp and Paper Industry.
 This revised version includes changes to the text for purposes of clarification and completeness,
 as well as new results of the financial analysis of two pollution prevention projects  in the pulp
 and paper industry.  The latter changes reflect both refinements to the analytical tool used in
 the  original  profitability analysis  and the availability  of new data on the costs and  savings of
 the  projects  themselves.

        In  the case of Project  1, a white water and fiber reuse project in a coated/fine paper
 mill, the revised analysis substantially strengthens the Total Cost Assessment  in relation to  the
 Company  analysis using  three indicators  of profitability.   The revised analysis  shows  an
 increase in Net Present Value (NPV, 15 years) from approximately  $360,300  to $2,851,900;
 Internal Rate of Return (IRR, 15 years) increases from 21% to 48%; and  Simple Payback
 decreases from 4.2 years to 1.6 years.  In contrast, the revised analysis for Project No. 2, shows
 a  TCA  analysis  less profitable  than the  Company  analysis, largely  owing to  substantial
 increases in utility costs for operating an aqueous-based  coating process. NPV decreases  from
 approximately -$203,600 to -$395,600; IRR decreases from 11% to 6%;  and Simple Payback
 increases from 7.6 to 11.7 years.

       Taken together, the two revised analyses reinforce  the central finding  of the original
 study ~ that improved managerial accounting systems, including accurate measurement and
 allocation  of both physical and cost aspects of waste  generation, are essential for achieving a
 clear, unbiased perspective  on the profitability of industrial pollution prevention investments.


 BACKGROUND

       In its February 1991 National Pollution Prevention Strategy, EPA set in motion a series
 of initiatives aimed at deepening  and widening both government and private sector activities
 in pollution  prevention.   Recognizing the inherent  limitations of traditional "end-of-pipe"
 approaches, the Strategy called for joint agency-industry action to redirect resources  toward
 elimination of  pollutants  instead of continued  reliance  on downstream,  control-oriented
 approaches that, while effective in solving one pollution  problem, often create others. Without
 a transition from control to prevention strategies, cross-media shifting of pollution among  land,
 water and  air will continue, and reduction of pollution from dispersed, non-point sources will
 remain extremely difficult to achieve.

       For many firms, EPA's call for accelerated prevention served as a reaffirrhation of what
they already knew and,'to  varying  degrees,  practiced—that  in  the  medium  and  long-term,
pollution  prevention  generally is more sensible  than pollution control.    Early  initiatives,

                                            1

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  beginning in the 1970's,  were motivated by a simple .bottom-line consideration:   continued
  expenditures  on pollution control investments  to handle  steadily increasing  waste volumes
  presented  firms with the specter of an endless capital drain that would divert resources from
  more lucrative opportunities in R&D, product development, manufacturing and marketing.

         By the mid 1980s, other  forces were encouraging the shift to prevention-oriented
  strategies,  including  liability  under  the  federal  Superfund  Act,  public   concerns  with
  environmental degradation, increasingly stringent pollution disclosure requirements, and widely
  publicized industrial  accidents in both the U.S. and abroad.  As a result, firms have faced  a
  rising  tide of public demands for shifts to  clean  technologies  and  environmentally friendly
  products.

        Notwithstanding pressures from various quarters, and the  noteworthy progress of a few,
  typically large firms, manufacturers have been slow to move away from traditional end-of-pipe
  strategies toward more prevention-oriented practices.  If, as many argue, pollution prevention
 pays, what accounts for this slow  pace of change? If prevention investments  are, in fact, in
 the self-interest of the firm, what accounts for the continuing reluctance to move aggressively
 toward a more preventative pollution management mode?  And why, in light of the publicized
 benefits  of pollution  prevention,  do firms,  even large sophisticated ones,  continue to  be
 surprised .when prevention-oriented projects  produce advantages to the firm far beyond those
 expected of many conventional  "must-do," compliance-driven capital investments?

        The explanation  for this  apparent  contradiction  seems  to  be  two-fold:    (1)  the
 organizational structure  and behavior of firms inhibits pollution prevention  projects from
.entering their  decision-making  process from the outset, thereby  precluding these alternatives
 from consideration by the firm altogether;  and (2) economic/financial  barriers  linked  to
 methods of capital allocation and budgeting  after a pollution prevention  project successfully
 enters the  capital  budgeting process and competes with other projects  for  limited capital
resources.  A  priori, it appears that  both these  factors, acting  in concert, contribute  to the
sluggish pace  of investment in industrial pollution  prevention.

       Economic/financial  barriers, the second of the explanations we  propose,  is the focus of
this study.   Within  a capital  budgeting framework,  we examine if, and to what extent,
conventional methods  of investment  analysis act to impede pollution prevention projects  in
favor of end-of-pipe  alternatives.  Two projects actively under consideration  by firms in the
pulp  and paper  sector serve  to demonstrate how different definition,  measurement,  and
allocation of project costs/savings,  longer time horizons, and the use of multiple profitability
indices  may remove the" biases inherent in conventional financial methods.
THE PULP AND PAPER SECTOR

       As  a major source of industrial pollution, the pulp and paper sector provides a useful
context for examining these alternative methods. Historically, environmental regulation of the

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 industry has focused on reduction of BOD and TSS in water effluent, and particulates, sulfur
 dioxide and  organic  sulfur compounds in air.  Reductions  of these pollutants have been
 achieved principally through end-of-pipe controls. Nonetheless, pollution prevention is by no
 means a new concept  to  pulp and paper firms.   In-plant recovery and reuse of pulping
 chemicals,  for example, is an integral part of the kraft pulping process.  Other preventive
 measures include:  in-plant fiber and water recovery and  reuse in the paper mill,  counter-
 current  washing  in the pulp mill, and dry wood debarking  in  the woodroom.   These
 technologies have been  widely implemented to reduce pollution generation and to reduce raw
 material and energy costs.  Current environmental regulation of toxic air and water pollutants,
 toxic constituents in mill sludge, and pulp mill effluent standards for  foam, odor, and color are
 posing new challenges to pulp  and paper firms. Meeting many of these regulations will require
 materials and process changes rather than traditional  end-of-pipe controls.  Dioxin reduction,
 for example, requires process changes targeted at reducing dioxin formation, such as decreased
 use  of chlorine in bleaching or oxygen delignification.
       In a compliance context, a mill's choice between an end-of-pipe or a prevention strategy
 will depend heavily on the comparative economics of these  options.   This  is so  even in
 instances where  profitability  is negative, that is, when the firm expects  a net  loss on its
 investment. Unlike most end-of-pipe technologies, pollution  prevention projects tend to reduce
 operating costs by  reducing  waste generation,  regulatory  activities, and pollution  related
 liabilities.  In addition, investments in pollution prevention may increase revenue by improving
 product or corporate image. Including these indirect  or less tangible savings in the  financial
 analysis  of projects may enhance the estimated profitability of the prevention strategy,  and may
 be decisive in selecting a  pollution prevention  versus  an end-of-pipe option.   It is at this
 decision point that the  concepts  and methods  of  Total  Cost Assessment  (TCA) ~ the
 comprehensive, long-term financial  analysis of pollution prevention projects — can play a role
 in improving the financial  picture of a pollution prevention  investment, and  enhance  its
 competitiveness vis a vis pollution control projects.  TCA  techniques can also improve the
 projected financial  performance  of discretionary  pollution   prevention  projects,   thereby
 increasing their ability to compete for limited capital  resources.
CASE STUDIES

       To assess how TCA works in practice, we worked in close collaboration with the staff
of two mills to analyze the economics of two pollution prevention projects. The first (Project
1) is a white water and fiber reuse project at a coated fine paper mill.  This investment would
permit fiber, filler, and water reuse on two paper machines at all times, thereby conserving raw
materials  and  reducing  water use, wastewater generation, and energy use for fresh and waste
water  pumping  and freshwater heating.    The  second (Project  2)  is  a conversion  from
solvent/heavy  metal paper coating to aqueous/heavy metal-free coating at a paper coating mill.
This investment  would substantially reduce  solvent and heavy-metal usage, VOC emissions,
and hazardous waste  generation, while increasing  water,  steam,  and electricity  usage and
increasing wastewater  generation.   For both projects, we  developed a "company analysis"
comprising  costs typically used by the firms. We compared these to "TCA analyses" of the

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  same project, in which a full accounting of less tangible,  longer term, and indirect costs and
  savings was made.  To do this, we developed  a spreadsheet system called P2/FINANCE  to
  collect  and organize capital and operating  cost data,  to  calculate  cash flows and  financial
  indices, and to perform sensitivity analyses of the  case studies.
 COST INVENTORY

        While cost categories considered in a financial analysis will tend to differ according to
 the nature of the project, we can infer from the Company Analyses the types of costs that these
 firms typically consider in project analysis.  Table ES-1  presents an  overview of the costs
 estimated in the Company Analyses and the TCA.  The TCA column represents a complete set
 of known internal costs and revenues affected by the project.  By comparing the Company
 Analysis column against the TCA column, a picture  emerges  of the  firm's project costing
 approach. .                                .

        Direct and Indirect Costs.  Had a full financial analysis  of the white water/fiber reuse
 project (Project 1) been done by the  mill prior to this study,  energy savings  associated with
 reduced fresh and waste water pumping and treatment and freshwater heating would have been
 omitted.  These energy savings, which are included in the TCA, represent a substantial benefit
 of the project.   Their  omission in a  traditional  financial analysis would have drastically
 underestimated  the profitability of the investment.

       In  the case  of  Project  2, the  Paper  Coating  firm omitted all non-disposal  waste
 management  costs,  utilities (energy, water  and  sewerage),  solvent recovery,  and regulatory
 compliance costs from its analysis of the aqueous conversion  project.  The  firm also omitted
 several costs  associated  with the storage needs and shorter shelf life  of aqueous coatings,
 namely a steam heating system for the coating storage shed, lost raw material value, and the
 cost to dispose of spoiled coating.

       Future Liability Costs.  In this study we have focused  on two general forms of future
 liability costs:  liability  from personal injury or property  damage (e.g.,  Superfund liability
 stemming  from a leaking  landfill), and penalties  and'fines for violation  of environmental
 regulations.  In the case of Project 2, the Paper  Coating firm  did not include an estimate  of
 avoided future liability costs owing to  reduced hazardous  waste disposal  in their own financial
 analysis.  They did. however, allude to this benefit in a qualitative way in their Appropriations
 Request: "...major reductions in levels  of fugitive emissions, and amounts of solid hazardous
 waste  going to landfill, -is very  positive from a regulatory  and community standpoint".   The
 TCA developed for this  project includes an estimate of avoided future liability.  Since Project
 1 does not involve hazardous materials or waste, neither  the Company Analysis nor the  TCA
contains a future liability estimate.

       Less Tangible  Benefits.  Less tangible benefits from pollution prevention investments.
such as increased  revenue  from enhanced  product quality,  company or product  image, and

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  reduced worker health maintenance  costs or productivity are certainly the most difficult  to
  predict and quantify.  Neither Company Analyses nor TCAs  contain estimates of less tangible
  benefits.  In the case of Project 2, the coated paper product is sold domestically, on the basis
  of cost,  visual appearance, and performance  durability,  to  book  publishers  and  other
  intermediate  product  manufacturers.     Although  the  company  expects  some   quality
  improvements using aqueous  coating,  it does not anticipate an increase in market  value.
  Therefore,  it expects no  increase in domestic  sales as  a  result  of the conversion  to the
  aqueous/heavy metal-free coating.  The  company  hopes to improve its competitive advantage
  in the European market if the European Economic Community implements lead-free packaging
  standards (which would apply to books) as expected.  However, it would not speculate  on the
  potential revenue effects associated with increased European market share.

        The Coated/Fine Paper Mill  does not expect  an  increase in market share or  product
  value  from  its  white water/fiber reuse  project.   Both the  mills  are manufacturers  of
  intermediate, rather than consumer products,  and cannot directly market their products on the
  basis of environmental performance in the way that a consumer products company like Procter
  and Gamble can and does.

        A reduction in solvent  use at the  Paper Coating firm will. certainly  reduce  worker
 exposure to fugitive solvent emissions, and the elimination of nitrocellulose from the  coating
 mixture will reduce fiammability and explosivity  hazards.  While reduced solvent exposure
 may result  in a lower incidence of worker illness  over the long-term, and the elimination of
 nitrocellulose may result in fewer worker injuries, we did not have adequate  information to
 estimate the potential impact of these benefits on either the  company's health care costs or
 long-term  worker productivity.  This issue was dealt with qualitatively  in a section  of an
 Appropriations   Request,  developed  by the company,  called  "Safety/Health  Impact of
 Converting from Solvent to Aqueous Coating", which listed specific project benefits that will
 improve safety and industrial hygiene.

       Many company representatives noted that project benefits are more persuasive  if they
 are monetized and included in the project financial analysis.  However, when costs are difficult
 or impossible to  monetize,  a qualitative  approach may be more credible with management.

       Omitted non-environmental  costs. In developing the TCAs for the two projects, we
 attempted to add  to the Company Analyses any capital or operating costs or savings that could
 be attributed to the project and reasonably estimated.  While our focus was on environmental
 costs typically omitted from project analyses, the process of developing a more comprehensive
 list of costs (or "casting the cost net wider") unearthed other, "non-environmental" costs that
 were not considered by the company.   In the case of Project 2, all previous company analyses
 of the aqueous/heavy-metal free conversion had omitted the costs of heating system installation,
 the energy needed to prevent the aqueous  coating from freezing, and  the additional  energy
 needed to dry aqueous versus solvent-based coating.  While the latter cost was acknowledged
 by several  production  engineers and managers in meetings with Tellus,  it had never  been
estimated nor included in previous analyses.

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         The effect of such costs on a project's financial performance depends upon whether the
  item represents a cost or a savings  for the project.  In the case of Projects land 2, these
  non-environmental costs tended to increase the total cost of the project by adding to capital and
  operating costs.  While this finding  is probably not a surprise to those who prepare project
  analyses, it is important to point out that the TCA process may reveal additional costs as well
  as savings for the project.  If the financial impact from the addition of regulatory compliance
  or waste management  activities is marginal, they may be negated by the addition of one or two
  previously omitted non-environmental costs.
 FINANCIAL INDICATORS

        Financial indicators are a critical, though not exclusive, ingredient in justifying pollution
 prevention projects.  Firms typically use such  indicators  as guideposts rather than decisive
 elements in judging the merits of a proposed project. Their application tends to be flexible,
 that is, subject to substantial management discretion as proposals move through the formal or
 informal budgeting process and compete against one another for scarce capital.

        For the relatively large companies included in this study, payback (or the slightly more
 sophisticated ROI)  is typically used as a first screen.  If a project passes a prescribed hurdle
 rate, a more m-depth analysis  that computes NPV and/or IRR is common. The Paper Coating
 Company uses ROI to screen proposed projects before subjecting them to more in-depth NPV
 and IRR analyses.  The Fine/Coated  Mill  uses  payback in a similar fashion.   This practice
 provides the project proponent with an informal estimate  of expected performance  prior to
 investment  of staff resources (and personal  capital)  in advocating a proposal.   Once  this
 milestone is passed, the proposal typically moves into a divisional or sectoral review where
 more complex calculations are developed to capture the  longer-term costs/savings.

       In none of these  cases is the  hurdle rate inflexibly applied.   Instead, there  are
 perceptions associated with each project that are  defined by the project's place in the strategic
 thinking  of top management  and the degree to  which outside pressures  from  customers
 regulators,  or the community  are  applied.   In the case  of the Coated Fine Paper  Mill, the
 professed hurdle rate for projects is a 2 year payback. However, certain production-oriented
 projects  have been implemented without  meeting  this rate, primarily because there was  a
 general  perception  among decision-makers  that  these  projects were needed to  maintain
 productivity.   On the other  hand, discretionary  environmental projects are  more rigidly
 measured against the company's hurdle rate.  This seems to be a result of an impression that
 environmental projects by nature are virtually  always unprofitable.

       To examine the effect of the choice of financial indicators and time horizon, we created
two functional categories  of indices:  discounted  cash flow methods that consider a stream of
future  cash flows for the investment (e.g. NPV and IRR). and one which does not (e.g. simple
payback  period).

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 TIME HORIZON

        Time horizon, of course, is closely tied to financial indicators.  Simple payback and ROI
 calculations are  not capable of  capturing  long-term costs/savings,  a  particularly  severe
 shortcoming in the case of liability estimation where benefits may materialize 10 years or more
 into a project's lifecycle.  NPV and IRR, on the other hand, can account for costs and savings
 as they occur in  future years.  Their use is typically associated with large firms and large
 investments whose  market and budgeting horizons are expansive, and who are able to  wait
 many years for a stream of benefits to materialize.

        In  preparing  the TCA for the  Paper Coating  Mill, managers indicated  that a  time
 horizon of 10 years is typical for major investments.  The need for extending this figure to 15
 years to capture the liability avoidance benefits became evident in preparing the TCA analysis;
 if the  time horizon was less than  13 years,  the liability estimate would not  have been
 incorporated into  the financial indicators.   In the case of the Fine/Coated Paper Mill, once  a
 discretionary project such as the white water/fiber reuse system passes an informal payback
 screening, it is subjected to a 10 year discounted cashflow analysis. Since the TCA for this
 project did not involve any costs (e.g. future liability costs) that would be incurred in the  out-
 years, the  time horizon  is less critical to capturing the full financial impact of the project. In
 any case, the linkage between financial indicator, time horizon, and cost inclusion is a powerful
 rationale for promoting  and practicing TCA in pollution prevention project analysis.
PROFITABILITY  ANALYSIS

       The comparative analyses for each project yield substantially different results.  For
Project 1, the white water and fiber reuse investment, the net present value (over 15 years) for
this  SI.5  million capital expenditure shifts from $0.36  million in the Company Analysis to
S2.85 million using a TCA approach; the internal rate of return (IRR) increased from 21% to
48%; and the simple payback of 4.2 years decreased to 1.6 years, well within the mill's 2-year
payback rule of thumb.   By  excluding the savings associated with  freshwater pumping,
treatment,  and  heating, and waste water pumping,  the Company Analysis makes the project
appear substantially  less profitable than it actually  is.

       Contrasting results are produced for Project 2, the aqueous conversion investment. NPV
for this $0.9 million  capital expenditure  shifts from -$0.2 million  to  -$0.4  million  in the
company versus TCA analyses, respectively; IRR shifts from 11% to  6%; and simple  payback
rises  from  7.6 to  11.7 years.   The  inclusion of previously  omitted  savings  for waste
management, regulatory compliance, and future liability in the TCA are  outweighed by the
previously omitted  utility costs.  As a result, the TCA  analysis  illustrates that the proposed
project is actually less profitable than originally thought.  Nonetheless, the exercise achieves
its ultimate goal - providing a clear, comprehensive picture of the investment option.

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 IMPLICATIONS

        Analysis of this limited sample of two projects does not suggest that, a priori, more
 comprehensive treatment of project costs and savings necessarily yields higher performance for
 prevention investments.    Much depends on  the original capital  cost  of the project,  the
 completeness  of the company analysis, and the magnitude and timing  of indirect  and less
 tangible benefits.  And, surprisingly, TCA is equally likely to turn up additional  costs as well
 as additional savings, potentially diminishing the appeal of prevention investments.  Moreover,
 the effort expended in preparing the TCA analysis, though partially attributable to startup costs
 of any new practice, is substantial  enough to make even large firms wary of adopting such an
 approach for all projects competing for capital resources.

        The limited number of cases  examined here precludes generalizations  about overall
 corporate receptivity to TCA approaches and the degree to which pollution prevention will be
 accelerated by its adoption.  Within the limitations. of our study, however, it is clear that TCA
 can  serve as valuable tool for translating discretionary judgements into concrete dollar values
 during the capital  budgeting process.   Insofar as pollution prevention  projects produce less
'tangible and indirect costs and  benefits, TCA equips  managers to develop a more precise
 estimation of the real financial  returns to such projects.   Though TCA does not insure an
 attractive profitability level for prevention projects, the cost  characteristics  of such  projects
 suggests that their financial performance in general will be enhanced by TCA.  This  is likely
 to be particularly true for industrial prevention projects that are materials and process-focused,
 that is, well  upstream in the  production  process.  Over the  longer term, TCA can  serve as a
 substantial force in recasting the "must-do"  and "inherent loser"  image of environmental
 projects into a more positive, profit-adding and market-expanding image.

        Several approaches  for promoting TCA in the context of EPA's  pollution prevention
 strategy emerge from this  study.  In general,  it  is clear  that moving firms to modify their
 analytical  procedures requires a  belief that TCA will  produce  a clearer picture  of the
 profitability of prevention projects and thereby managerial decision-making. Thus, the primary
 goal of a promotion program should be to  convince firms that TCA is  not simply another
 regulatory mandate, but a vehicle for rationalizing their internal capital  budgeting process.

        More concretely, EPA has already worked to promote TCA by developing the Pollution
 Prevention Benefits Manual, the Waste Minimization  Opportunity Assessment  Manual, and
 sponsoring the initial work on PRECOSIS, all of which contain discussions  of TCA concepts
 and provide analytical tools.  Further efforts  to  disseminate more widely these and other tools
 such as P2/FINANCE, a tool developed for  this study, will accelerate the advancement  of the
 TCA concept.  Published case studies which use a TCA approach to project  financial  analysis
 could  be a valuable supplement to past initiatives.

        At the state  level, TCA may be built  into pollution prevention policies and programs
 in several ways.  State technical assistance programs may offer TCA guidance and training as
 a complement to their technical services, by providing TCA training seminars, with specialized
                                            8

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  modules aimed at large versus small firms, or for firms in certain lines of business. A number
  of states have instituted requirements for industry to develop  pollution prevention plans that
  must contain technical and economic feasibility assessments of specific prevention  projects.
  The New Jersey Pollution Prevention Act, for example, explicitly requires that plans include
  a comprehensive analysis of the costs associated with the use, generation, release or discharge
  of hazardous  substances  for current production  processes  and  the savings  realized  by
  investments  in  pollution prevention.  Planning for Success Through  Waste  Reduction,  the
 planning guidance  document  created by the  Washington State Department of Ecology under
 the State's Hazardous Waste Reduction Act,  instructs  companies to evaluate the costs and
 benefits of selected waste reduction options over a five year period.  It also requires firms to
 describe the accounting systems used to track hazardous  substance and waste management costs
 which must include "liability, compliance,  and oversight costs".

        Requiring a TCA  approach in pollution  prevention planning may  direct firms to
 incorporate   unconventional   cost  items  and/or   longer  time   horizons  to  enhance  the
 competitiveness of prevention investments.   The long-term effectiveness  of this approach,
 however, is unproven and should be approached cautiously and with a strong emphasis on the
 company self-interest alluded to earlier.  While rigid, prescriptive approaches are undesirable,
 some type of standard  could  facilitate  the  implementation of emerging  federal and  state
 regulations requiring TCA in pollution prevention planning.

        The limited  sample size of firms in this study allows for only indicative findings that
 must be corroborated  by the  analysis of additional cases.  Existing TCA  methods have been
 available for several years, yet no systematic assessment of user experience among the several
 hundred purchasers  of various systems is available.   This presents  a potentially rich data base
 for further assessing  the organizational  and  economic issues in TCA adoption which we
 uncovered  in this study.

       Quantifying  the benefits of green technologies,  green  products and green corporate
 image remains a major challenge.  It is precisely these benefits that are  heard by corporate
managers as reasons for approving otherwise marginal projects.  Developing methodologies to
quantify these benefits and incorporate them into project financial analysis is an unfinished
task.

       Finally, what is financially optimal for the firm, of course, is not necessarily optimal
from  a social cost standpoint.  In this sense,  TCA  is  no substitute  for lifecycle assessment
(LCA), in which the choice of a material input or the manufacture of a product is assessed for
its full societal costs regardless  of whether they fall within or outside the purview of the firm.

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 Table ES-1  Overview of Cost Inclusion by Company and TCA for Projects'1 and 2
 X = Cost(s) Included
 P = Cost(s) Partially Included

 Capital Costs

 Purchased Equipment
 Materials (e.g. Piping, Elec.)
 Utility Systems
 Site Preparation
 Installation
 Engineering/Contractor
 Start-up/Training
 Contingency
 Permitting
 Initial Chemicals
 Working Capital
 Salvage Value

 Operating  Costs
 Direct Costs:3
 Raw Materials/Supplies
 Waste Disposal
 Labor
 Revenues - General
 Revenues - By-products
 Other:
        Transportation

 Indirect Costs:4
 Waste Management
        Hauling
        Storage
        Handling
        Waste-end Fees/Taxes
        Hauling Insurance
 Utilities
        Energy
        Water
        Sewerage (POTW)
Pollution Control/Solvent Recovery
Regulatory Compliance
Insurance
Future Liability
                                           Project 1'
                                   Company        TCA
                          Project 22
                 Company        TCA
                                  X
                                  X
                                  X
                                  X
                                  X
                                  X
                                  P

                                  X
                                  P

                                  X
Notes:
I.
 X
 X
 X
 X
 X
 X
X
X
X
X

X
P
P
X
X
X
X
X

X
X
X
X
X
X
                                                                                    X
                                                                                    X
                                                                                    X
                                                                                    X
                 X
                 X
                 X
                 X
                 X

                 X
White water/fiber reuse project
Solvent/heavy-metal to aqueous/heavy metal-free coating conversion
We use the term "direct costs" here to mean costs that are typically allocated to a product or process line (i.e.
not charged to an overhead account) and are typically included  in project financial analysis.
We use the term "indirect costs" here to mean cost that ate typically  charged  to an overhead  account and
typically not included  in project financial analysis.
                                                      10

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 Table ES-2  Summary of Financial Data for Project 1 - White Water and  Fiber Reuse
 Project
       Total Capital Costs

       Annual Savings (BIT)*

       Financial Indicators
       Net Present Value  - Years 1-10
       Net Present Value  - Years 1-15
       Internal Rate of Return - Years 1-10
       Internal Rate of Return - Years 1-15
       Simple Payback (years)
                                              Company Analysis
 $1,469,404

 $ 350,670
 $  47,696
 $ 360,301
    17%
    21%
    4.2
   TCA

 $1,469,404

 $ 911,240
 $2,073,607
 $2,851,834
    46%
    48%
    1.6
       * Annual operating cash flow before interest and taxes
Table ES-3  Summary of Financial Data for Project 2 - Aqueous/Heavy Metal Conversion
Project
      Total Capital Costs

      Annual Savings (BIT)*

      Financial Indicator

      Net Present Value - Years 1-10
      Net Present Value - Years 1-15
      Internal Rate  of Return - Years 1-10
      Internal Rate  of Return - Years 1-15
      Simple Payback (years)
moanv Analvsis
$893,449
$118,112
TCA
$923,449
$ 79,127
($314,719)
($203,643)
   6%
  11%
  7.6
($480,512)
($395,625)
   0%
   6%
  11.7
      * Annual operating cash flow before interest and taxes
                                        11

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